When will Sterling hit Euro parity?

I caught a good article in today’s Guardian about the British Pound.  The question is: how weak will Sterling get?  My answer is below 1-to-1 with the Euro.  But before I tell you why, let me interject a blurb from the article.

The world’s foreign exchanges were today readying themselves for parity between sterling and the euro after further selling sent the pound to within touching distance of a one-for-one exchange rate against the European currency.

Fears of a severe UK recession in 2009, the weakness of the dollar prompted by the Israeli attacks on Gaza and thin post-Christmas trading all contributed to a 2% fall in the pound yesterday. At its lowest point this morning the pound was worth €1.0265, slightly up on the previous day’s low of €1.0198.

The euro has risen by almost a third against the pound in the course of 2008, with an 18% appreciation in December alone. Sterling’s trade-weighted index against a basket of currencies fell to 74.2% of its 2005 value, its lowest since the Bank of England first kept daily records in 1990.

Although the cheaper pound makes UK exports more competitive on world markets and encourages foreign visitors to Britain, it also means dearer imports and makes overseas travel more expensive.

Financial markets believe that UK interest rates – already at a record-equalling low of 2% – will be cut further in the new year as the Bank seeks to revive an economy that is on course to suffer its weakest year since the early 1980s.

Edward here. As much as I hate singing the same tune as everyone else, I have to agree with the tenor of the article.  The U.K. will suffer some horrific mortgage default levels in 2009.  I guarantee you that puts Mervyn King into a dovish frame of mind.  What’s more is the Europeans are not going to do the same.

“There’s a sense that UK rates will fall closer to zero, and that the Bank may be forced into some sort of quantitative easing, while there’s no sense of that in the eurozone,” said Daragh Maher, senior currency strategist at Calyon in London.

Well said.  I should also point out that going to zero gives one no incentive to use the repo market and it makes money fund yields after fees below zero.  This is what is hapenning in the United States and is one reason I see the Dollar lower.  The Europeans are not going to do the same.

But I am betting the BoE does.

Sterling within a whisker of parity with the euro – Guardian

  1. Edward Harrison says

    I can't fault your analysis, especially when it comes to propping up the economy. And I agree that the Germans are going to be surprised by the extent of banking problems there. The Landesbanken have a lot of losses that will come ashore in 2009. As for Deutsche (my former employer) they have a lot of leverage to the commercial real estate sector in the US and Germany. Morgan Stanley, by the way, does as well. I definitely see some writedowns coming from that sector. Let's see how the ECB responds then.

  2. Edward Harrison says

    Nick, like a lot of people I see the BoE as genetically more inflationary than the ECB. This is probably because we have transferred our view of the German and Dutch Central Banks to the ECB and consider it a very Germanic institution. The Bundesbank loathed inflation and would just not go for easy money. To date, the ECB has shown the same predisposition. Their former chief economist, Ottmar Issing, a veteran of the Bundesbank was instrumental in making the ECB seem like a 'German' institution.

    Ultimately, however, the institution is untested. Will they flinch? No on knows. But, the common belief is they will not. By the way, I should mention that the Swiss National Bank, previously the hardest of the hard money crowd, has effectively reverted to a zero interest rate policy. So there's a precedent right there.

    Nick, where do you come down on this one?

  3. Nick von Mises says

    In this case I have a personal interest because 90% of my assets are cash accounts in sterling and I didn't see the sterling crash being so severe :-(

    I think EVERBODY is heading for ZIRP and I think the BoE was just quicker to the draw than the ECB for the historical/cultural reasons you mention above. Germany needs to prop up its exports so I think the ECB will come under alot of pressure to weaken the Euro and this will coincide with lots of bad debt in the banks, especially Deutsche. The Swiss example surprised me at the time, but it's like a microcosm of Germany cos they abandoned a history of hard money in order to prop up exports and horribly overleveraged banks.

    I suspect Europe is behind the UK on the credit cycle a little. Remember the US had it's dollar crash while sterling was high and the Brits were laughing at the yanks over it, then BOOM four months later sterling tumbles. I suspect the Germans are about to go through the same humiliation. Don't really know, though.

    I'm quite happy with weak sterling for a year or two if it'll prop up the economy and then apprpeciate before I start looking to buy foreign assets.

  4. Nick von Mises says

    So I take it you aren't expecting (i) Trichet to capitulate when he finally recognises deflation (ii) the Germans to realise all those Beemers and fridges need to find buyers in order to leave the docks (iii) Euro-zone banks to suffer from the Eastern Europe and Latin America bubbles popping and (iv) The PIGS to start squealing about leaving the Euro and taking their naturally-high-interest-rate economies with them?

    Not saying you're wrong, but both the ECB's competence and nerve are overrated IMHO.

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