Sterling parity with the euro drew closer yesterday as the single currency surged through the 95p mark to hit an all-time high of 95.56p, on mounting talk of benchmark UK interest rates tumbling to zero.
Sterling parity with the euro drew still closer yesterday as the single currency surged through the 95p mark to hit a fresh all-time high of 95.56p, on mounting talk of benchmark UK interest rates tumbling to zero.
Currency experts believe it ever more likely the market could push the euro up all the way to one pound, although some of these same people also consider such a move entirely unjustified in terms of economic fundamentals.
It was on Monday this week that the euro went through the 90p mark for the first time since the single currency's launch in January 1999.
As recently as July 2007, the euro was trading below 67p.
Sterling was hit hard yesterday by comments from Bank of England deputy governor Charlie Bean that UK base rates, which stood at 5% as recently as early October, could fall from their current level of 2% "all the way to near zero". He also talked about a potential need for further capital injections into UK banks.
The pound sustained heavy losses against the US dollar as well as the euro during yesterday's session.
The single currency was last night holding at around 95p - up more than 2p on its close in London on Wednesday.
Sterling tumbled to an intra-day low of $1.4890 during yesterday's session - nearly six cents lower than its close in London on Wednesday. The pound was last night trading at around $1.50, still nearly five cents weaker than its Wednesday close.
Asked if the euro was going to be driven up to parity with the pound, Royal Bank of Scotland currency strategist Neil Parker replied: "To be honest, it is obviously a growing risk. For the life of me, on a fundamental basis, I can't understand why people think the euro is a better bet The markets have stumped me on this one because it makes no logical sense."
He added: "You only have to look at the economic construct of euroland. It is far more heavily weighted towards manufacturing - therefore they need a competitive exchange rate rather than a very strong exchange rate.
"That part of the economy which isn't weighted towards manufacturing certainly relies a lot more on tourism than the UK does. One would question whether people would decide to travel abroad with the euro as strong as it is. It has been demonstrated that its (euroland's) financial services sector is equally as hampered by the lack of liquidity as the UK and the US's."
Parker made no bones about his surprise about how far the euro had risen. He said: "On three specific areas, (mainland) Europe is at best in the same position as the UK and US, if not worse. We are all sort of scratching our heads a little bit saying, How far can this go and how much can the euroland economy bear?'.
"I can't see the euroland economy coming out of recession in 2009 if the euro remains as strong as it is at the moment and if the European Central Bank keeps dragging its heels on rate cuts."
Eurozone interest rates stand at 2.5%, following a three-quarters-of-a-point cut by the ECB earlier this month.
They are therefore significantly higher than the UK base rate of 2%, which is expected to be slashed again next month by the Bank of England.
The Federal Reserve cut benchmark US interest rates from 1% to between zero and 0.25% on Tuesday night.
John Higgins, senior markets economist at consultancy Capital Economics, highlighted the growing likelihood that the Bank would follow the Fed by taking benchmark UK interest rates down to zero and then "printing money" to raise the monetary base.
He noted that the dollar had been hit this week by financial markets' fear that measures to increase the monetary base would fuel inflation.
However, Higgins said that dollar weakness against the euro would not last because financial markets would eventually come round to the view that the "Fed isn't hell-bent on producing inflation" but is rather "tackling deflation" to allow the US to exit recession sooner.
He believed, given the Bank of England is closer to the Fed in lowering interest rates and thinking about taking measures to increase the monetary base and that the ECB is "at the back of the queue" in this regard, that the pound would also benefit from this eventual change in market viewpoint.
Noting sterling was being hit by worries among financial market players that the recession could be worse in the UK because of the high level of indebtedness and the poor state of the housing market, and the "herd mentality" of traders, Higgins told The Herald: "I would not be surprised if the market did try to take the euro-pound up to one. That isn't our baseline expectation. Our baseline expectation is it is more likely the pound will strengthen more against the euro than fall over the next six months."
He added: "If you step back, I think there are reasons not to become overly concerned about sterling. Let's not forget the currency has already plummeted pretty dramatically not just against the euro but against the dollar from where it was in 2007.
"The decline in the real trade-weighted value of the currency is pretty similar to that when we exited the ERM (European Exchange Rate Mechanism) in 1992 From a fundamental perspective, sterling is now no longer clearly overvalued."
As recently as July this year, the pound was trading above $2.
The pound fell to a fresh record low yesterday on its trade-weighted index against a basket of currencies, of 76.6. This is the poorest level yet in daily records compiled by the Bank of England and dating back to 1990.
Parker highlighted increased trading volumes in foreign exchange markets amid the turbulence.
He said: "I reckon volumes have increased something between 15% and 20% this year. Because the moves (in exchange rates) are occurring, there is more volume going through. Because there is more volume going through, the moves are getting larger."
Experts' surprise about the level to which the euro has surged against the pound would appear to raise the possibility that the single currency could turn tail fairly quickly after reaching parity. Such a turnaround is not uncommon when a key level is reached in foreign exchange markets. However, foreign exchange experts are well aware the current volatility adds to the usual peril of short-term forecasting of currency rates.
