The effective exchange rate has fallen by 25% since July 2007. This represents the largest depreciation over 17 months in the history of the index (going back to 1960).

At various stages of this plunge Bank of England Governor Mervyn King has spoken approvingly of a lower exchange rate. For example, in a speech in January he stated:

If we are to raise our national saving rate without overall demand, output and employment suffering in the medium term, we will need to export more and import less. Such a rebalancing is helped by the fall in sterling’s effective exchange rate. Sterling has fallen, against a trade-weighted basket of currencies by almost 10% since August. And financial markets are pricing in a significant probability of a further decline in the exchange rate during this year.

During the press conference to present the November Inflation Report, when asked whether the large decline in sterling worried him, Mr. King replied:

Well clearly if sterling falls far enough this will be a concern and it will have an impact on inflation. I think it is not surprising that it has fallen over the past year...And that can be a helpful part of the rebalancing provided it doesn't threaten our ability to meet the inflation target.

Policy-makers’ comments arguably have little long-run impact on exchange rates. However, there is evidence that Mr. King’s remarks have had at least a short-term effect. The effective index has fallen by an average of 8 basis points a day since its peak in July 2007. Mr. King has given six speeches and presented at six Inflation Report press conferences over this period. The average daily change in the index following these 12 appearances was -50 bp. (This refers to the change on the day of his appearance when this occurred within trading hours or on the following day in the case of evening speeches.)

Mr. King’s view that a lower pound supports economic activity is questionable, particularly under current circumstances. British banks are dependent on overseas wholesale funding to bridge the gap between their UK-based deposits and lending. Net sterling borrowing from overseas stood at £162 billion in October, equivalent to 11% of GDP. Expectations of continuing sterling depreciation could lead to a withdrawal of this funding or an increase in its cost, thereby further tightening domestic credit conditions.