Saturday, May 30, 2009

Predictions for Pound Sterling

(updated June 09) In 2008 and early 2009, the pound was weak because
  • UK interest rates fell from 5% to 0.5%
  • UK entered deep recession. The reliance on the finance sector meant the UK was hit hard.
  • The UK was quick to pursue a policy of quantitative easing (increasing money supply) this has potential to cause inflation and devalue the exchange rate. (money supply and exchange rates)
  • High levels of government borrowing and the potential inflationary nature of this borrowing - especially if government monetise debt. (why high debt affects exchange rate)
  • The Pound was overvalued by early 2008 as the UK experienced relatively high interest rates and a long period of growth
However, in recent months, the pound has strengthened. This is not because of a turn around in the UK economy, but a realisation that other EU countries and the US face similar, if not more serious problems.

For example, the German economy has suffered much more than expected because of a strong Euro, and collapsing export demand.

Although the UK economy still faces great uncertainty there are tentative signs of recovery. The Housing market looks more settled than in the depths of the 2008 slump, other areas of the economy are showing tentative signs of recovery. Also the quick fix of low interest rates and quantiative easing have helped boost chances of economic growth and inflation. If inflation does return to the UK, then interest rates will rise making the Pound more attractive.

The outlook for the Pound looks uncertain. A strong low inflationary recovery would help the pound maintain it's strength, but at the moment a strong recovery is very unlikely. I expect any recovery to be quite weak and the high levels of debt will keep foreign investors nervous of investing in the UK.

At the moment, the biggest factor in favour of Pound Sterling is the fact our competitors are facing a similar economic downturn and economic problems.


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