What's Wrong With Sterling?
April 1st, 2008
Brits thinking about buying property abroad are wondering why the Pound has fallen so far against the Euro. Currency specialists, Moneycorp, say many factors are involved but at least two of them involve house prices in the UK and US.
Northern Rock came to grief in September when it could not borrow enough money in the wholesale market to finance its portfolio of mortgages. The queues of nervous depositors made investors wary about the UK financial system and, in turn, wary of the Pound.
Northern Rock’s problems had arisen because of nervousness about the US mortgage market where foreclosures and repossessions were adding to the real estate depression. The Bank of England foresaw serious knock-on effects for the UK economy and shared its thoughts with the media.
Investors were left with the idea that a slowing UK economy would mean tumbling interest rates, making Sterling progressively less attractive as a currency in which to invest. After four years of stability the Pound suddenly became a basket case.
Sterling has an unfortunate track record. In the last 20 years there have been a handful of incidents which have sparked sharp falls in the value of the Pound. The most famous was when Sterling’s ill-fated flirtation with membership of the European Monetary Union fell apart in the autumn of 1992.
The short term picture does not look good. When the Pound dropped through €1.38 at the end of last year it cleared the way for a further fall to €1.20, Sterling’s low point against the ECU in 1995. Technical targets are not necessarily realised but analysts would not be surprised if the Pound were to fall below €1.20.
Putting on the rose-tinted spectacles for a moment it is possible to imagine a different outcome. Sterling’s recent under performance has been because the Euro zone has acquired the reputation of being immune to the problems facing Britain and the States. But the fact that it has not suffered so far does not mean that it will never suffer.
If we see evidence that the European economy has problems of its own, investors will have to revise their blithe assumption that Euro interest rates will never ever go down. Such a development would level the playing field and give the Pound scope to recover some of its losses.
Real estate in Spain, or anywhere priced in Euros, is now more expensive for British buyers than it was in the first half of 2007. If the Pound really does fall below €1.20 those prices will go up further in Sterling terms.
For investors who have already taken the plunge it means an increase in the Sterling value of their investments. It also means more expensive holidays or reduced spending power from their pensions.
In six months’ time, Sterling might be in a better position than it is at the moment but maybe not by much. The Pound has taken a severe beating since September 2007, and the downward pressure has probably been overdone. Whether or not we see €1.20, there is almost certain to be a bounce. Only in the very worst cases (such as the Turkish Lira in the nineties or the Zimbabwe Dollar today) does a currency experience losses, never to return.
Planning your currency requirements can have a significant effect in reducing the uncertainty of volatile exchange rates.
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