1996 (see Structure of the BoP accounts), there was a £2bn. deficit in the Balance of Payments (Imports + Capital Outflows > Exports + Capital Inflows). Other things being equal, this deficit (supply greater than demand) should have led to a depreciation of the exchange rate to Ee - the exchange rate was "too high" in 1996. This depreciation was prevented by the Bank of England selling some of its own Forex reserves and thus adding to the demand for £s by £2 bn. This "official financing" of the Forex market supported the exchange rate at $1.6/£ (at Ea) rather than allowing it to depreciate to Ee.
Since the UK was operating under a floating exchange rate system in 1996 (and still is) the implication of the 1996 BoP account (with a negative balance offset by a running down of the Forex reserves) was that (over the course of the year) the exchange rate was tending to depreciate, with the Bank of England slowing this depreciation by buying in £s and selling forex reserves. In fact, by the last quarter of 1996, the exchange rate began to appreciate (allowing the bank to begin to re-build forex reserves by selling £s and buying forex). It appreciated and remained strong, at least against the Euro, throughout the 1990's and early 00's.
Since the UK was operating under a floating exchange rate system in 1996 (and still is) the implication of the 1996 BoP account (with a negative balance offset by a running down of the Forex reserves) was that (over the course of the year) the exchange rate was tending to depreciate, with the Bank of England slowing this depreciation by buying in £s and selling forex reserves. In fact, by the last quarter of 1996, the exchange rate began to appreciate (allowing the bank to begin to re-build forex reserves by selling £s and buying forex). It appreciated and remained strong, at least against the Euro, throughout the 1990's and early 00's.
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