More than likely the largest single factor that will affect demand for the pound is the economic health of the United Kingdom or how the market is expecting the UK economy to fare in the future.
Sterling is what is known as a free floating currency, so its exchange rate or its price in relation to another currency is determined purely by supply and demand. In simple terms the more the pound is in demand internationally, the stronger its exchange rate becomes.
Investors tend to move money away from weakening economies. The worsening of expectations for the economy in the UK during 2008 goes a long way to explain sterling’s sharp decline.
The exchange rates and how they are affected by the strength of the pound. A higher interest rate will mean you will get a much better return on bonds and other Government securities and therefore this in turn will tend to attract financial capital from abroad. If currency markets expect the United Kingdom base rate to fall, the pound as a knock on effect will tend to weaken.
A currency is likely to weaken in order to correct a big trade deficit, which is unsustainable in the long-run, therefore making cheaper exports and imports much more expensive.
One of the most immediate effects that this has on most families is an increase in the cost of travelling abroad. As a pound buys less of a foreign currency, hotels abroad, goods and services will become much costlier.
This will also mean that imported goods to the United Kingdom in turn will become more expensive to consumers and to businesses that import raw materials and components as part of their production process. Meanwhile exporters who price their goods in sterling will benefit as their goods will become cheaper in overseas markets
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