Stephen Hughes is Associate Director at foreign exchange provider Foreign Currency Direct. For further information, visit www.currencies.co.uk.
Why is the pound continuing to flounder?
Q. I own a property in France and am used to seeing the euro rate at between 1.35 and 1.45. Why is sterling continuing to struggle so much?
Duncan Grubb, London
A. The ongoing failure of the British banking system and the difficulties individuals and businesses are experiencing in taking out loans are among the main factors pressurising the pound and keeping it at, or around, record lows against the single European currency. Over the years, the British Government has spent considerable time extolling the benefi ts of a banking sector free of state and regulatory control to members of the Eurozone, and this reversal of affairs has damaged our international standing and the value of sterling.
A continuous stream of poor data coming out of the industrial, retail and housing sectors is adding to the problem. Market jitters havent been helped by billionaire investor Warren Buffett comparing the recession to an economic Pearl Harbour and his worst case scenario prediction of a five-year delay before recovery.
As culpable politicians highlight the global nature of the crisis, why is sterling looking so much more vulnerable than the dollar, despite Warren Buffetts comments? One explanation for this comes from one voice in the City who said, All central banks are pursuing unconventional monetary policies now, but the Bank of England is pushing the boundaries further than others. He went on to describe the Bank of Englands policy of quantitative easing as the most aggressive in the industrialised world.
What is quantative easing and will it improve the exchange rate?
Q. I keep reading about quantative easing but don't really understand it. Do they really just print more money? And will it improve the euro-pound exchange rate?
Simon Weirmouth, Newcastle
A. Unfortunately it isnt quite as simple as printing more money, but it isnt too far removed from that. Quantitative easing is a tool used by the central banks of different countries when they are unable to reduce interest rates any further or when previous reductions have not had the desired effect.
Quantitative easing basically involves the Bank of England creating money to buy back Government loans, which forces those who used to invest in them to put their money elsewhere. Doing so increases the amount of currency in circulation, which reduces the value of the currency and boosts infl ation. A simpler way of looking at this is to imagine that your favourite musician, say Michael Jackson, was doing a one-off concert, with 25,000 tickets worth 150 each. Suddenly he decides to do another concert, meaning that there are now another 25,000 tickets available.
As a result of supply and demand the price of each individual ticket decreases. Having more tickets available for a cheaper price should allow even more people to be able to afford to go, and hence interest in the concerts increases and activity in the concert ticket market goes up. In many ways, the goal of quantitative easing is the same; to try and increase activity in financial markets. By creating more money the central bank aims to promote lending and prevent a shortage in the future.
In recent years, quantitative easing has been tried with some success in Japan and less successfully in Zimbabwe. It is very diffi cult to gauge how this may affect the foreign exchange market. It is likely to depend on the markets reading of how well it fits with the other measures being tried by the Government. Remember, most currency brokers have tools and mechanisms available to protect you against adverse market movements, which can be useful in the current uncertain times.
This article was published in the Show Special 2009 issue of A Place in the Sun magazine. To order a back issue call +44 (0) 20 3207 2920 or to subscribe click here.