Britons travelling to the eurozone face a “currency crunch”, as The Independent’s Martin Hickman puts it. The euro has hit a record peak of just above £0.80, having gained around 17% over the past year. On a trade-weighted basis – against a basket of major trading partners’ currencies – sterling has hit an 11-year low.
The dollar is “the rare currency against which the pound has not taken a battering”, as Economist.com notes, but it lost 1% last week and is currently below the $2 mark.
Since early 1997, the pound has gradually been “dragged into the dollar’s orbit”, says Economist.com. Britain shares many of America’s problems, including a current account deficit and a struggling housing market; indeed, the housing bubble has been bigger and household debt levels are even higher here at 160% of disposable income. The UK is also more dependent on the financial sector, which is suffering from the credit crunch.
As the economy continues to weaken amid the credit crunch, further interest rate cuts are on the cards, which will weaken the yield on UK assets. Conversely, given relatively solid recent data and historically high inflation of 3.5%, no interest rate cuts from the ECB appear to be “on the horizon”, says Martin Slaney of GFT Global. So the “squeeze on sterling against the euro looks set to persist” for now.
As the pound comes under “continued pressure” thanks to tighter credit and slowing growth, underperformance against the dollar also looks likely, according to Phylis Papadavid of Société Générale. A recent Capital Economics note sees scope for the pound to fall to $1.70 against the dollar by the end of the year.
Note, too, that while the current account deficit narrowed sharply in the fourth quarter of 2007, this reflects foreign-owned banks earning less income owing to the credit crunch; the balance in trade on goods has kept sliding and is now at 6.6% of GDP, as HSBC points out.
What’s more, the direct investment inflows stemming from the boom in M&A activity were a key prop for sterling in recent years, and these have now gone into reverse. The risks to the pound “remain on the downside”.