Why is sterling weakening so much against the euro?

Sterling’s recent falls have been dramatic to say the least, and people who were ‘waiting out’ what they considered to be a bad rate a few months ago have been badly burnt. Many wonder why this is happening, but if you look at sterling’s credentials on paper, it actually makes some sense. The reasons behind the pound’s falls can be seen as follows:

UK interest rates are now lower than in Europe, and predicted to go even lower

UK public debt is considerably higher than Europe

An unusually high proportion of the UK’s economy is in the financial sector – the hardest hit by the credit crunch. Europe on the other hand has a more diverse economy, which makes it less vulnerable

The euro is fast being viewed as a rival to the dollar as a world reserve currency. Stability in interest rates has supported this in recent weeks

On the other hand...

The economic situation in the euro zone is far from being rosy. Today (Friday 19 December) the German Producer Price Index – a key indicator for inflation – showed the biggest fall since records began. Along with low consumer sentiment this would suggest that the European Central Bank’s reluctance to cut interest rates is actually hurting the economy. This adds pressure for them to follow the Bank of England and cut rates further. This may put a hold on the euro’s sharp ascent but will unlikely take it back to previous levels.

Elisabeth Dobson, Head of private clients at currency exchange broker, World First, says, “I think it is important that people realise we are now in a totally different economic climate from that of only a few months ago. The rates we have enjoyed in recent years are not going to return in a hurry, and parity with the euro is a very real risk. This is something we are just going to have to get used to.”

So what can you do?

Elisabeth continues, “If you need to buy over £100k worth of euros, you should be looking at currency options which protect you from further rate falls as well as allow you to benefit from the rate improving in the short, medium and long term.

“For amounts less than £100k, look at fixing the exchange rate now with a forward contract for your full transaction amount to protect you from further sterling depreciation. Alternatively, you can hedge your risk by booking half the euros you need now with a forward contract, leaving the other half open so you can benefit if the rate improves.”

Elisabeth says, “If you have property overseas earning you a rental income, repatriating that euro income will currently buy you more pounds sterling than ever before.

“Equally, if you have sold your overseas property and want to bring the proceeds home, the euro exchange rate has never been better.

“Another option is to release equity from your overseas property and transfer those euros to sterling in order to pay off UK debts, for example.”