Sunday, February 5, 2012

Predictions for Pound Sterling to Euro

Predictions for Pound Sterling to Euro in 2012

Readers Question: I read a lot about the Dollar/Pound relationship but I want to know what the forecast is going to be for Euro/Pound. What is the factor that determines the value of the Pound down against the Euro?

The Main factors determining the value of the Pound Sterling to Euro
  • Relative interest rates - If UK interest rates are higher than Eurozone, this will attract hot money flows from Europe to UK. This will increase demand for sterling, and sterling will appreciate
  • Prospects for economic growth. If the UK economy grows quicker than the Eurozone, we would expect UK interest rates to increase faster than in Euro, causing an appreciation in Sterling.
  • Prospect for inflation. If UK inflation is higher than in Eurozone, it will make UK goods relatively less competitive than Euro goods. This will cause less demand for UK goods and a devaluation in the value of Sterling.
  • Government Debt. If markets fear government default, this makes them less willing to hold currency which the debt is denominated. If markets feared the UK government may default, foreign investors would sell UK bonds, pushing down the value of the exchange rate.
Graph showing Value of Euro to Pound

Reasons Why the Pound Devalued against the Euro in 2008/09

  1. UK Economy in steepest recession. The UK economy experienced a rapid drop in GDP (Steeper than even Great Depression of 1930s). The UK was particularly hard hit by credit crunch because of the UK's exposure to financial services. Because of the sharp slowdown in UK GDP interest rates were cut to 0.5% in March 2000
    Lower interest rates are very important for weakening a currency. Lower UK interest rates make it less attractive to buy Sterling and save the money in the UK. Therefore, there are less hot money flows and a weaker value of Pound.
  2. Housing Market. The UK Housing Market plays a crucial role in determining consumer confidence, spending and economic growth. The fall in house prices has reduced consumer confidence and with house prices forecast to fall or stagnate in 2012, it is another factor which will keep interest rates low.
  3. Credit Crisis. The UK is heavily exposed to the credit crisis because mortgage lending accounts for a high % of disposable income. Mortgage lending is more important in the UK than the Eurozone where mortgage payments account for a smaller % of disposable income. With less mortgages becoming available, demand for housing is falling. Also those with existing mortgages are seeing the cost of remortgaging increase. This is putting pressure on the Bank of England to reduce base rates to compensate for the increased bank rates. As they explained the recent interest rate cut:

    "The disruption in financial markets could lead to a slowdown in the economy that was sufficiently sharp to pull inflation below the target."

  4. UK Current account deficit. Relative to the EU, the UK is running a current account deficit, which puts downward pressure on sterling because of the outflow of foreign currency. UK's current account deficit is still 4% of GDP (Q3 2011) despite devaluation.
  5. Large Rise in Government Borrowing. With government bailouts, fiscal expansion and tax cuts, government borrowing will be close to 9% GDP in 2012/13. This causes lower confidence in the UK economy to pay off debt (though UK public sector debt is still lower than many of our European counterparts)

Predictions for Pound vs Euro in 2012

The Euro has become increasingly weak since the onset of the Euro debt crisis in early 2010. Markets fear default in countries like Greece, Italy and Portugal. This could lead to countries exiting the Euro. This uncertainty and fear over default has pushed the Euro lower. There is no quick fix to the Euro debt crisis. Efforts to reduce government borrowing have caused a slowdown in economic recovery and prospects of a double dip recession make markets more nervous over the Euro.
The UK's recovery is being held back by the Eurozone downturn. The UK is highly reliant on the EU for our exports. However, the UK still has greater flexibility than the Eurozone and recovery is likely to be stronger in the UK than in the south of Europe.

The strength of the Euro is also causing problems for EU exporters.


The Pound has fallen on the back of depressing economic statistics. The whole Global economy is likely to experience recession, but, the UK recession has been deeper than most. Against this backdrop the pound has been weaker.

Picture from : Guardian - Pound falls to record low


Anonymous said...

2009,complete collapse of the pound and dollar against the euro.UK will join the Euro 2010,aqnd the Amero 2010 will come into circulation.Civil unrest will prevail 2009 throughout europe and USA.

Anonymous said...

Very useful, thank you!

Anonymous said...

good explanation, but hardly a prediction of what is going to happen....

Unknown said...

And thats what the Business world wants is it!! Crash the £ so they have to join the Euro! The British economy is supposedly picking up compared to Eu!! The People of Britain will NOT join the Euro! If anything, they want to be rid of EU altogether and trade fairly with the rest of the world, rather than bow down to EU beaurocrats.
Should Britain pull out, the EU, would go Bankrupt,and they know it!We are led to believe,the Euro is strong.Not worth the paper its printed in Britain on.Paid themselves far too much in their so-called Exchange-rate-mechanism.Prime example is now Cyprus! £(Cyp)=1.71Euro's. They are suffering heavily for it. Shops empty,restaurants almost empty. Tourist's Gone.Building Industry In-Hock to the Banks. Export's 300ml Euro's.Imports 1000ml.So what's the rest of Europe like. Remember when Euro 1st started,it nose-dived to 29p.And didnt they panic!Just an over-inflated currency and nothing more.Britain pays more into EU than any other nation! And for what benifit!The Nation is Bleeding to Death by them!
An interesting thought!Look @ your computer Key Board!You will notice Only 2 currencies on it!Yep!Thats right,the £ & $!The Euro NOT good enough to have a distinguishable place in Technology! How many millions out there!Should I say BILLIONS! Makes you think, dos'nt it! Germany's industry is in the doldrums.Look @ BMW. France's food industry is SUBSIDISED by Britain!
Do I need to go on! And we allow them to flock through the Sewer in Droves.(Sorry,meant Euro-tunnel) to take our jobs, & put our communities on the Dole heap! Hence the millions now un-employed.
Maybe it's time the British said NO MORE! Enough is enough!

Anonymous said...

Rather emotional outburst from Jon. Much of it completely ill informed and without concrete evidence.

Jon, if you are out of work, I suggest you go back to school and learn economics. The real truth is out there and a lot different to your rather biased interpretation.

Anonymous said...

"Rather emotional outburst from Jon. Much of it completely ill informed and without concrete evidence."

Have to say I totally agree with that observation! What a complete idiot.

Anonymous said...

Sterling will be in trouble as long as the UK is obsessed by house prices and the gov/banks and public conspire to keep them artificially high.
Little property developers or buy to letters rubbing their hands with glee whilst the RoW looks on scratching their heads.
As well as interest rate levels which means that some are quids in whilst others are not through pure luck, I see that councils are now assisting by lending sums to first time buyers.
This is wrong the market should be left to fall - too much wasted effort has gone into this sector and illusionary wealth generated - let it fall to a more natural level and then maybe first time buyers will be able to afford homes without mortgaging their next 70 years, and Britain will be able to concentrate on industries and services which the rest of the world want. Otherwise we get what we deserve.
Do I sound bitter - no I have a house - but it is so wrong that rising house prices are seen as a good thing.

Elliot Moran said...

"Rather emotional outburst from Jon. Much of it completely ill informed and without concrete evidence."

"Have to say I totally agree with that observation! What a complete idiot."

Think you're being kind there.
It's this kind of ill-informed short-sightedness that has plagued our country.

qjames said...

Germany props up the EU. Has from the start and continues to the present. True, Britain is a net contributor, but it is the Germans who have paid for the bulk of the EU plan, not to mention bailing out the bankrupt Russian Economy in the late 90s while paying for their reunification.
Britain is bleeding to death from incompetent New Labour economics.
Remove the plank of wood from your own eye before you type anymore...€€€ that's the euro sign on my British keyboard. What decade are you living in?

Anonymous said...

"Thats right,the £ & $!The Euro NOT good enough to have a distinguishable place in Technology!"

Hilarious. Yes the pound (I have a US keyboard so it isnt on mine) and $ sign do appear on a UK keyboard, but not keyboards produced for other countries.

Clearly Jon is an ill informed idiot who has never left the comfort of his backyard.

Im British BTW and I dont think we should joing the Euro at present. This has nothing to do with Patriotic nonsense and everything to do with the fact that our economy and the Eurozone economies are too different - one of the main ones being that as in the UK many people own their homes and rely on interest rates the Bank of England MUST be able to set its own interest rates with accordance to the direction of the housing market, otherwise disaster would loom.

Deviza Árfolyam said...

Duncan Higgins, Senior Analyst at Caxton FX said ‘Despite the consumer price index holding at 3.1% last month, the members see little change in the upside risk to inflation. As long as inflationary pressures are downplayed, it appears the door is likely to remain open to further quantitative easing, a prospect that will continue to weigh on sterling going forward.’