Is sterling about to bounce back?
After almost 18 months of widespread weakness in the face of the credit crisis and economic recession, it seems sterling might be on the mend against the dollar and the euro.
As Adam Bobroff, director of dealing at Foremost Currency, observes, the pound was "desperately oversold" as people rushed to the safety of the dollar when the credit crisis hit the UK.
Historically, £1 averages around $1.55 and around €1.40, but sterling dropped to around $1.35 and parity with the euro in December 2008.
However, Bobroff says there's a link between the fortunes of the equity market and sterling - as the FTSE strengthened in the spring/summer equity rally, the pound also recovered.
"Now, with recent economic indicators suggesting that we're slowly pulling out of recession, people are starting to buy back into sterling," he says.
Ready to rally
Commentators expect this trend to continue. Bobroff predicts the pound will reach around €1.20 by the end of 2010. It will also rally against the US dollar from its present $1.66 to around $1.75, or $1.80 by the second quarter of 2010.
But he adds: "To some extent, this will reflect efforts by other nations - particularly the Chinese - to undermine the dollar's position as the world currency in favour of the Chinese yuan, by selling dollars.
"Indeed, the yuan is a currency to watch - it has already strengthened over the past year despite the current trading restrictions on it. These will unwind gradually and it's likely to gain more ground."
Mark O'Sullivan, director of dealing at Currencies Direct, believes sterling could gain 10% to 15% against the dollar, euro and yen in the coming year, given that it's now markedly undervalued, in historical terms, against all of them.
He predicts that £1 could be worth €1.25 by the end of 2010. In the US, where interest rates are set to remain ultra-low, £1 could be worth more than $1.80. Against the Japanese yen, where, at the time of writing, £1 is worth around 146 yen, O'Sullivan suggests £1 could be worth 175 yen.
Of course, such predictions are based on the premise that the UK economy continues on its upward trajectory, inflation remains under control and no problems are encountered in raising debt in the bond markets.
A hung parliament in the forthcoming general election is another potential problem, as it could result in a lack of economic direction and strong leadership, adds O'Sullivan.
But what does a strengthening currency mean for investors? "Once sterling is moving upward, it's time for UK investors, especially in the property market, to start looking overseas because their buying power is increasing," he explains.
"We've seen a lot of clients start to look abroad in traditional areas such as Florida, France and Spain, while property prices there are still low and sterling is undervalued. We've also seen sterling movement into the US equity market."
Investors often make use of strategies such as forward contracts (where a fixed price is quoted for a set date in the future) to protect themselves against the risk of adverse currency moves.
Retail investors are also increasingly turning to currency options that work effectively as an insurance policy, in that they pay an upfront premium for the right to buy or sell at a certain agreed rate on a certain date.
If the market rate has risen above that level they let the option lapse, thereby losing the premium, but benefiting from the higher exchange rate.
In a generally rising market, there is less call for hedging strategies because you're likely to get a higher rate if you wait. However, there are various situations in which you may wish to reduce uncertainty about how much your sterling will be worth in the future.
Bobroff explains that if you can wait for a favourable currency move, it's possible to fix rates for future overseas payments of sterling (for example, pension payouts) for a given time frame, thereby avoiding the risk of being hit should sterling then weaken again.
Expatriates wanting to sell their property and return home can benefit by agreeing a future rate for a set date, but at a time when sterling is at a low point against the euro.
This article was originally published in Money Observer - Moneywise's sister publication - in January 2010
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).