Interest Rates and Euro Exchange Rates

With press speculation that Sterling – Euro exchange rates might reach parity (£1 = €1), what is driving sterling down against the single currency at the moment?

One of the main drivers is interest rates. The Bank of England have cut rates from 5.75% last December, to 2% now. This means that international investors (pension funds, hedge funds and other investments) get a lower rate of return on sterling-denominated assets, so they move their money elsewhere.

This, in turn, means that there is less demand for Pounds. The simple rule of supply and demand applies, and the price of the Pound drops. Therefore, the price of other currencies relatively, increases.

As the Bank of England is likely to cut interest rates again in January, there is little stimulus to bring funds into the UK – specially in the current economic climate with all the other problems our economy is facing. Therefore, the selloff continues, and the Pound continues to fall.

In Europe, interest rates have also come down – but not as much. From 3.75% in the Spring, recent cuts now leave the single currency at 2.5%. Further, ECB President Jean-Claude Trichet said this week that there is little room for further cuts (analysts expect another 0.25% trim in January) which means that returns on Euro assets are seen as significantly higher than in the UK.

The Euro is quickly becoming a “safe haven” currency in these difficult times. Massive movements into Euro-held assets are driving up the price of a Euro – and it’s a relentless acceleration in the single currency’s value.

Euros are currently around 15% more expensive than just 2 months ago.

If you are sending money overseas in the coming weeks and months, this is not comfortable reading. Of course, things can change very quickly, and if the Eurozone finds itself in more economic trouble than we currently know about, then its currency could weaken and the best exchange rates could improve. But the risk is that the run will continue.

In addition, shopping around for the best Euro rates can save you money against your bank. Tom Arnold, Sales Director at Currency Index Ltd, said “now more than ever, buyers of overseas property are checking what deals are available on their currency purchases. Using a specialist broker such as ourselves can make a huge difference to the amount paid for a place in the sun or retirement property abrad”.

Specialist companies can also offer services like advance booking of exchange rates. Any volatility over Christmas would therefore not affect orders placed in advance, to give some peace of mind.

Whatever happens, we are in unchartered territory on the money markets, and buyers or sellers of any foreign currency should beware of assuming that things will move in their favour. Indecision, as the saying goes, can be much more expensive than a poor decision.