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Where Now For The Euro/Pound Exchange Rate?

By Tony Green - Tue 30th Jun 2009

We have seen some extreme changes in the Euro/Pound exchange rate over the past couple of years which has had a bearing on most of us in some way or another.

In January 2007 the rate was hovering around 1.50 euro to the pound, but during the following two years the rate had dropped to 1.00 euro to the pound – a fall of 33%.

Since the January 2009 low, we have seen a steady recovery in the UK currency to 1.18 Euro to the pound.

This exchange rate volatility has, for example, increased quite considerably the cost to UK residents intending to travel to European destinations for holidays - many preferring to forego an overseas vacation for one in the UK instead. Another impact of these movements has been felt by the many British people who have retired and taken up residence within Europe. Invariably their pension arrangements are in sterling and so a 33% change in the exchange rate can be a disaster.

There are number of ways of protecting against future exchange movements based on selling/buying currency at various dates in the future based on likely cash flows.

I believe that in the majority of cases individuals are not fully conversant with these procedures and would not fully be aware of the consequences if their circumstances were to change.

One possible solution would be for Britain to join the euro which would completely alleviate these problems. With the pound at its current level this would be a tempting option for the UK government and there would be some trade advantage for the UK.

One of the biggest drawbacks of joining the euro would be in monetary policy where the UK would lose the ability to set its own interest rates.

The UK Prime Minister's popularity amongst the electorate is at an all time low and joining the euro would be his worst call since he lost £2 billion selling the UK’s gold reserves at a 20 year low. He can not and will not risk any further loss in confidence.

I think the most likely scenario for the exchange rate is for a period of relative calm with the rate moving within the 1.10 – 1.20 euros to the pound range for the next few months. I believe that the problems experienced by the UK banking sector have now been fully exposed (and are being addressed) whereas within Europe there is still problems within this sector which have not yet come to light. Interest rates in the UK are at historic lows however inflation will be a major factor at the point in time when the recession is over. The Bank of England will act quickly to raise rates at the first signs of inflationary pressures within the economy.

My feeling is that higher UK interest rates and possible problems within the European Banking system will weaken the Euro against the pound and we could see an exchange rate of around 1.50 euro to the pound at some time next year.

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