Sterling: a strong currency, and the price of doubting it

Sterling is the official currency of the United Kingdom, issued by the Bank of England and one of the oldest currencies still in use anywhere. Its value, measured against the dollar or the euro, rises and falls with interest rates, inflation, trade and, above all, the market's judgement of whether the government can pay its bills. In mid-September 2026 a pound bought roughly 1.33 US dollars.

Most explanations of sterling stop at the exchange rate. They tell the reader what moved and not what it cost. The cost, once counted, falls on every household that buys imported food, fuel and goods.

Main points

• As to what drives the pound: sterling follows interest rate differentials, inflation and, most of all, confidence in the public finances.
• As to Brexit: the 2016 referendum triggered a sharp one-off fall, but the larger and more recurrent shocks to the pound have come from fiscal credibility, not from trade.
• As to households: a weaker pound raises the price of imported goods, and the weaker the pound the longer the pass-through into shop prices.
• As to the Bank of England: the Monetary Policy Committee held Bank Rate at 3.75 per cent in a 6 to 3 vote in September 2026, with three members preferring 4 per cent.
• As to the gilt market: borrowing costs near 5 per cent on ten-year gilts mean that every spending promise is also a promise to the bond market.
• As to the prescription: a credible currency needs a credible Treasury, and no amount of exchange rate commentary substitutes for either.

What determines the value of sterling

The value of any currency is a price, and like any price it reflects supply, demand and expectations. For sterling, four forces dominate. The first is the gap between UK and overseas interest rates: when Bank Rate is high relative to the Federal Reserve or the European Central Bank, holding sterling pays more, and demand rises. The second is inflation: persistently higher inflation erodes a currency's purchasing power and, over time, its exchange rate. The third is the trade balance, where the UK runs a persistent current account deficit that must be financed by overseas investors. The fourth, and the one most often neglected, is confidence.

Confidence matters because the UK finances its deficit by selling gilts, and the buyers of those gilts are also the holders of sterling. When they lose faith in the fiscal plan, they sell both at once. Herein lies the central paradox of the modern pound: it is a freely floating currency that behaves, in a crisis, rather like a confidence trick that has stopped working.

How Brexit affected the value of sterling

On 23 June 2016 the United Kingdom voted to leave the European Union. Within hours sterling fell by roughly 8 per cent against the dollar, to its lowest level in more than three decades. That was a market repricing of the risk that trade with the UK's largest partner would become more expensive and more uncertain.

It is worth noting that this was a re-rating, not a collapse. The pound stabilised, and in subsequent years it has traded in a range shaped by interest rates and global dollar strength. Our own analysis suggests that the Brexit effect on the exchange rate was real but one-off, and that the pound's larger recent swings have been driven by domestic policy rather than by the referendum. The Office for Budget Responsibility has estimated that Brexit will reduce long-run productivity by around 4 per cent relative to remaining in the EU, which is a cost of its own, but one that is spread over a decade and paid through lower growth rather than through the exchange rate.

Critics argue that the weaker pound after 2016 raised living costs. That is true. It is also true that it supported exporters and the competitiveness of British manufacturing. A currency that adjusts is doing its job. The question is not whether the pound moved but whether policy has made the adjustments larger than they needed to be.

When the pound loses its nerve: three cautionary tales

Three episodes show how fast sterling can move when the markets lose confidence.

On 16 September 1992, known as Black Wednesday, the UK was forced out of the European Exchange Rate Mechanism. Bank Rate was raised twice in a single day in a failed attempt to defend the pound. The policy of pegging to a stronger partner's currency had given the illusion of stability but the reality of copying the neighbour's policy without having any say in it.

In 2016 the referendum result produced the fall described above.

In September 2022 the so-called mini-budget of unfunded tax cuts pushed gilt yields sharply higher and sent sterling close to parity with the dollar, at around 1.03 to 1.04, a record low. The Bank of England was forced to intervene in the gilt market to stabilise pension funds. The cost to mortgage holders, in the form of higher fixed rates, was immediate.

The common lesson is plain. Sterling falls when the markets doubt the government, and the households who pay for the doubt are those least able to hedge against it.

Sterling in 2026: the new Prime Minister and the gilt market

The pound's recent behaviour illustrates the point. When Andy Burnham became Prime Minister on 20 July 2026 and appointed John Healey as Chancellor, the response in the bond market was telling. Ten-year gilt yields rose to a little above 5 per cent after early comments about flexibility within the fiscal rules, and thirty-year yields reached their highest level since late May. They eased after the Chancellor's appointment, and sterling edged higher.

Whatever else that is, it is not a vote of confidence in an expansionary fiscal stance. It is the market pricing in the possibility of a looser policy and asking for a higher return in compensation. The Autumn Budget will be read in the same light. The government has also announced the removal of VAT on energy bills, a measure the Treasury will need to fund from elsewhere. It is for the government to decide, of course. But the gilt market will have its say.

Sterling and the dollar, euro and yen

The pound is conventionally quoted against the US dollar, and that rate depends as much on the Federal Reserve as on the Bank of England. In September 2026 the Fed raised its target range to 3.75 to 4 per cent, above Bank Rate, and sterling slipped from about 1.35 to about 1.33 against the dollar in a week, a fall of roughly 1.2 per cent. Against the euro the pound has been more stable, reflecting similar rate paths in London and Frankfurt.

Sterling remains one of the most traded currencies in the world, ranking fourth in the Bank for International Settlements surveys of foreign exchange turnover. That depth is an asset. It means that the pound can absorb large flows without the violent moves that afflict smaller currencies. It does not mean that the pound is immune to bad policy.

The household bottom line

Put simply, a weaker pound makes imported goods dearer. The UK imports a large share of its food, fuel and consumer goods, and the pass-through from a weaker exchange rate into shop prices typically takes a year or more. A 10 per cent fall in sterling, if sustained, would add to inflation for the better part of two years and would push Bank Rate higher than it would otherwise be. That in turn raises the cost of every mortgage that resets.

For a family with a typical mortgage, even a modest rise in the rate it pays is a large sum over a year. Every additional percentage point on a mortgage of £150,000 costs £1,500 a year in interest. That arithmetic is unforgiving, and it is why currency stability is a household issue as much as a City one.

Best case, worst case

In the best case, the Autumn Budget is credible, the Bank of England gradually lowers rates, and sterling trades in a stable range around its present level. Even then, the UK would remain dependent on overseas investors to finance a persistent deficit, and exposed to any change in their mood.

In the worst case, the market concludes that borrowing is on an unsustainable path. Gilt yields rise, the pound falls, imported inflation returns and the Bank is forced to hold rates higher for longer. That is the sequence the country lived through in 2022, and it is not a comfortable place to start again.

Does a currency need a nation behind it?

There is an institutional point that is often overlooked. Sterling is credible because the United Kingdom is large, diversified and has a central bank that is a lender of last resort. A smaller entity that proposed to keep using the pound without a say in its management would hold the currency without the institutions that give it value. It would be a junior partner with a tiny balance sheet and no lender of last resort. This is the problem at the heart of the claim that Scotland could simply keep the pound: it is a proposal for the appearance of sovereignty with the reality of dependence.

The cautionary tale is Czechoslovakia, where the shared currency lasted only weeks after the state divided. The history is set out in our article on the break-up of Czechoslovakia.

What should be done

The prescription is straightforward. The government should publish a fully costed Budget and show that it meets its own fiscal rules. It should resist the temptation to loosen them for short-term political gain. The Office for Budget Responsibility should be allowed to scrutinise major measures in advance. And the Bank of England's independence should be defended, not tested.

Sterling does not need defending by speeches. It needs a Treasury that the market believes. Many of the current pressures are surmountable. However, a period of doubt would be costly, and the cost would fall on households and businesses.

Frequently asked questions

What is sterling? Sterling is the name of the UK's currency, the pound, and also the name for the system of British money more broadly. It is issued by the Bank of England and is one of the oldest currencies in continuous use. It trades freely against all major currencies.

How has Brexit affected the value of sterling? The 2016 referendum caused a fall of about 8 per cent against the dollar in a day. Since then sterling has traded in a range shaped largely by interest rates and fiscal credibility, and the larger swings have come from domestic policy rather than from the referendum.

What is the pound to dollar rate? In mid-September 2026 the pound was worth about 1.33 US dollars. The rate changes by the minute, so a live source is the only reliable guide.

Does a weaker pound hurt households? On the available evidence, yes. A weaker pound makes imports dearer and tends to raise inflation, which in turn keeps interest rates higher for longer. Exporters benefit, but most households are buyers of imported goods, not sellers.

Conclusion

Sterling is a currency of long standing and deep markets, and its strength rests on institutions, not slogans. The pound has fallen when governments have promised more than they could pay, and it has recovered when they have not. Households pay for the difference in higher prices and higher mortgage costs.

A currency, like a reputation, takes years to build and an afternoon to damage.