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Is the pound heading for parity with the euro?

Tim Wallace
Not what it was: those new pound coins are perilously close to falling to the same value as one euro - David Rose

Could the pound in your pocket fall in value so much that it is worth only one euro?

Sterling has never fallen that low before, even at the height of the financial crisis. At its lowest, in the depths of the credit crunch in late 2008, it still bought €1.03.

The most expensive bureaux de change at the airport do offer less than €1, and the market rate could be heading that way soon.

Right now the pound can buy €1.0816, up from a low of €1.0745 in the middle of the day yesterday.

Forecasters at HSBC expect the pound to fall to parity with the euro in the final three months of 2017 and to stay there well into next year.

That is driven by strength in the eurozone – the bank’s analysts believe that fast-moving investors have piled into the euro and should be joined by slower fund managers over the rest of this year.

Analyst Viraj Patel at ING fears that a “negative psychology” has developed around the pound in financial markets, such that when the euro is rising the pound is “a clear sell on rallies”.

And the euro is rising strongly.

Chart: How the pound’s value has changed over the past decade

A combination of sturdy economic growth in the eurozone, the European Central Bank’s plans to roll back quantitative easing, and disappointment in the dollar – which soared on Donald Trump’s election only to fall back when his promises failed to materialise – are putting upward pressure on the single currency.

However, the average analyst still expects the pound to stabilise at around €1.10 for the foreseeable future.

Mr Patel lists four factors which should keep the pound up above €1, at least for now.

First, he believes the scale of the fall in the pound “is now starting to look excessive relative to the near-term political risks at stake”, while the euro has been driven up by investors seeking a safe haven from political turmoil.

That reflects a combination of the Brexit vote and Donald Trump’s election in the US, as well as the victory of Emmanuel Macron in France, all factors which are now firmly built in to market expectations.

Second, he believes that politicians in London and Brussels are both determined to avoid any serious breakdown in Brexit talks.

Markets cannot yet price in the chance of a Brexit transition as it is not a done deal, but he expects that this will, in time boost sterling.

“For this to serve as a catalyst for a rebound in the currency, we would need to see evidence that a reduction in economic uncertainty is in fact spurring a rebound in investment activity,” Mr Patel said.

“This is what would give the Bank of England greater confidence to begin normalising monetary policy – which would undoubtedly be a positive sterling development.”

Third, his models suggests sterling is already 20pc undervalued compared with economic fundamentals, making it hard for the pound to fall further.

And fourth, his economist colleagues at ING do not forecast any further economic slowdown in the UK. Combined with the fact that the European Central Bank and the Bank of England are unlikely to want to see the current trends in currency markets continue for much longer, Mr Patel believes it is hard to see any reason for sterling to fall to parity with the euro.

The weak pound has not yet had the impact on trade which analysts expected – it should boost exports, but that hope has been disappointed.

But tourism is up, and foreign investment could also be rising. Those factors mean more people buying pounds, putting upward pressure on the currency.

Martin Beck at Oxford Economics sees an improvement in capital flows into the UK supporting the pound as international investors respond to the relatively low price of UK assets in their home currencies.

He sees political factors and the underlying nature of the economy pushing the pound up, and expects sterling to end this year at €1.09 and next year at €1.12.

“This is some way from the parity some are forecasting. In terms of support for sterling, we continue to think that the most likely outcome of the Brexit negotiations is agreement for a transition arrangement smoothing the UK’s departure from the EU and that negotiations will slowly move towards this outcome over the course of the coming year,” said Mr Beck.

“And history suggests that the UK economy possesses underlying strengths versus a still structurally dysfunctional eurozone, strengths which are unlikely to be completely neutered by current challenges.”

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