What Is An Exchange Rate? A Plain-English Guide (From Someone Whose Brain Fizzes When She Thinks About Them)
There are some things in finance that really twist my melon and exchange rates is one of them. I get the theory. I looked at it in fair detail when I was studying to be a financial adviser, when I’m changing my money for a holiday (if we even do that any more…) I can know what I’m doing but somehow, if I think too long about it it just explodes my brain.
So the fact that I’ve spent all week thinking about it, fiddling about with the maths and then making decisions about it is a total surprise to me. But here we are. Dr Chris and I are (probably, hopefully but not confirmed at the time of writing) buying a flat! But my deposit money, a mixture of savings and the proceeds of selling the shop, has been sitting in a British bank account waiting for its time to shine. And now is its time to shine so I had to work out how to get it all over here. It is a fair whack of money so even a small percentage difference in exchange rates (and fees) makes a difference.
This post is about what exchange rates are, how they move, how they can help or hinder you. In another post I’ll take you through some more practical stuff I’ve come across. I’m a coach not an adviser so I’m not telling you what to do, just sharing my experience and some general education.
So What Actually Is An Exchange Rate?
It is, simply put, a price.
It is the price of one currency if you buy it in another. Literally like the price of a loaf of bread, except the loaf is a Swedish krona and you’re paying in British pounds.
If the rate is 13 kronor to the pound, then £1 buys you 13 kronor. If the rate moves to 12, then £1 now buys you 12. Nothing about the £1 in your pocket has changed, you can simply buy a bit less with it.
In real life, this price is most likely the number on a screen and it can change minute to minute. Loaves of bread don’t tend to do that…
You might hear about the ‘mid-market rate’, also called the interbank rate. This is the middle point between what the banks are willing to buy and sell a currency for, and it’s what will turn up if you google ‘GBP to SEK’. The catch is that most of us will never actually get that rate - it’s a midpoint anyway and then banks and exchange services add their margin on top, so the rate you see is generally a bit worse than what you google and that’s how they make their money (without ‘charging you a fee’).
Why Do Exchange Rates Move?
Because they’re being traded constantly, all day, by banks, businesses, investors and governments so the price moves according to supply and demand. If lots of people want GBP then the pound ‘gets stronger’ i.e. it is worth more (maybe it can buy 15 kronor per £1) and if lots of people want to get rid of pounds then it gets weaker (so maybe you can only buy 10 kronor per £1).
What drives that demand is, predictably, a whole heap of things:
Interest rates. If the Bank of England raises rates then that makes holding GBP, rather than selling it, more attractive because you can earn more interest on them so the value goes up as supply slows down. The reverse is true too, of course.
The economy. Strong growth and low unemployment tend to mean a strong currency, and of course the opposite is true.
Politics and confidence in the country. Elections, referendums, budgets and civil unrest can have sometimes dramatic effects on a currency.
Inflation. If prices are rising much faster in one country then that currency will tend to lose value over time.
Global mood. In nervous times, perhaps a pandemic or a trade war, investors tend to pile into ‘safe’ currencies like the dollar and that will drag other currencies along with it.
Really, nobody can confidently and correctly predict which way a currency is going to go next. I’d suggest we can know that something will happen during a big crisis or event but what that might be is not set in stone. Even those old blokes on the news can’t predict it - if they really could, they’d be sat enjoying their very rich life rather than chatting to BBC News.
How They Normally Affect Us
For most of us, exchange rates are a background thing that only bothers us when we go on holiday. You might go to the cash point in Malaga and notice that your money isn’t buying as many cocktails this year.
Say you’re heading to Spain with £1,000 of spending money. If the rate is €1.17 to the pound then you’ll get €1,170 but if it’s dropped to €1.05 you get €1,050. So that’s €120 less paella. It’s annoying but you’re not going to cancel the holiday over it.
Of course the same thing can happen in reverse - when the pound is strong everything can feel like an absolute bargain!
People who are living on pensions are often a little more aware of exchange rates too. Where the pension is based matters (my nan relied on an Irish pension, so she felt every wobble of the euro). More commonly, if your investments are held in other currencies, the exchange rate can boost the gains or wipe them out, even if the investments themselves did fine.
If we assume most of us reading this are not yet drawing a pension though, we can say that exchange rates don’t affect most of us day to day and even when they do, it’s not a major issue. But…
When The Exchange Rate Becomes The Main Event
This is where it gets interesting (and my anxiety starts bubbling…). I’m going to keep these numbers really round and illustrative, so don’t quote me specifically. Let’s say you’re buying a house abroad, for simplicity we’ll say it costs 3,000,000 SEK.
At 13 kronor to the pound, that house costs you about £230,800.
At 12 kronor to the pound, that house costs you about £250,000.
At 11 kronor to the pound, that house costs you about £272,700.
Look at the difference! The house hasn’t changed. The financial position hasn’t changed. The money in my bank account hasn’t changed.
Just out of interest, I checked what the range of the rates were last year, the highest was 13.92SEK to the £ and the lowest was 12.34 - so the house could have cost £215,500 or £243,100.
Quite a difference isn’t it? And simply based on when you pressed a button.
And it can turn fast! After the Brexit referendum the pound dropped sharply overnight, it was a similar story after the mini-budget in September 2022 when the pound hit a record low against the US dollar. Trump’s tarrif wars and the war in Iran both had similar effect. Imagine if you were in the middle of a currency transfer then! Yikes!
When The Pound Is Strong, It’s A Gift
If you’re buying abroad when the pound is going well then you’re in a great position - your money stretches further and it can be the difference between a bougie holiday or a cheap bed and breakfast - or between the house that you want and having to compromise.
I’m in a weird position where my money is very much in pounds but my husband’s been earning in SEK for some time now and he feels fully settled. I had been hemming and hawing about what to do with this, whether I should keep an eye on exchange rates and pull the trigger when it seemed that the pound was doing really well. In the end I guess I chose to let fate decide. It could have ended badly but the pound was looking pretty alright at the time I did it - phew! (We did have some plans in place if it was a really terrible point, I can be slapdash with my hard-earned money only to a certain point!).
When I was studying to be a financial adviser, one of the exam questions was about a woman who owned a flat abroad and working out the different effects that selling the flat at a different time might have had plus some other interesting bits like a pension and a job. Weighing up and assessing the potential up and downsides of waiting to see if you could get a better rate. If you’re dealing with this sort of thing, especially if it's a serious amount of money, then this might also be a good time to see a financial adviser.
There’s The Theory Then…
The bit that makes my brain fizz a little. Next time I’m going to talk a bit about the practical side - what I ended up using and some of the questions I wish I’d pondered sooner.
In the meantime, if you're dealing with 'proper' money and an actual decision, that might be the time to see a financial adviser. But if you're trying to get your head around what's happening with exchange rates and how it might affect your position, we can totally chat that out in a coaching session. Come and find me.
Love Eleanor xxx
P.s. We’re buying a flat - ‘en lägenhet’ in Swedish - it’s super common to live in flats here and I didn’t like it but I’ve got used to it. I feel like in England, even if you live in a flat, you still refer to it as a ‘house’.
The equivalent word for a self-standing building where you occupy the whole of it, would be ‘en villa’ - they can sometimes be semi-detached type affairs too, and they’re sometimes known as ‘ett parhus’ or ‘a pair house’ in theory but I’ve only ever heard ‘en villa’.
There is a word ‘ett hus’ which does mean ‘a house’ but can also just mean a physical building. So a block of flats would be ‘ett flerbostadshus’ or ‘a many-living-house’ (that’s a very rough translation). Then there are terraces too which are called ‘ett radhus’ or ‘a row-house’, as in a row of houses. A hospital is ‘ett sjukhus’, so ‘a sick house’.
Sometimes a physical building is just called ‘en byggnad’ which is the Swedish equivalent of our ‘a building’ because ‘att bygga’ means ‘to build’. How cute is that?!
I just thought I’d give you a little Swedish lesson because I keep telling people I’m buying a house and then they’re confused that it’s a flat. I feel like that would not be confusing at all in England - like, you’d then say it was a flat maybe when you show them the photos but they would know that a house is just your home.
