Has The Pound Had Its Day Or Not?

London – 6 March 2009, Finance Watch

The British Pound Sterling is the world's oldest currency still in use. It is the official currency of the United Kingdom and its overseas territories including the Channel Islands and the Isle of Man and is ranked third in terms of international reserves after the Euro and US Dollar.

The British Pound is also the fourth most widely traded currency in the world after the Euro, US Dollar and Yen.

As the official currency of the British Empire, Sterling dominated international currency markets up until WW1. In the aftermath of WW1, the British government was left heavily indebted and it was this period that marked the ascent of the US Dollar at the expense of the Pound. The Bretton Woods agreement of 1940 pegged the value of Sterling at £1-$4.03, however in the 1970's this exchange rate broke down and Sterling became a free floating currency.

Despite being a member of the European Union, Britain along with Denmark, has negotiated an opt-out clause from adopting the Euro as a national currency. Replacing the Pound is a controversial ideal with the British public due to its symbolic value of British sovereignty. Debate continues over when, if ever the UK will adopt the Euro.

Economics

The British economy is based on the service and manufacturing sector and is the second largest economy in Europe after Germany. London, along with New York and Tokyo is one of the global centres for financial trading and e-commerce produces about 10% of UK GDP.

The Bank of England formed in 1694 is central to Britain's economic policy. The Bank was nationalised in 1997 and currently operates with the mandate of maintaining financial and monetary stability while keeping inflation rates as close as possible to 2%.

Setting interest rates is the primary tool the Bank uses to regulate the economy. Interest rates impact on Sterling internationally as they determine yields on investment as well as rates of growth and inflation. Generally speaking, low interest rates promote growth by making the cost of borrowing cheaper while higher interest rates slow growth down. In the wake of the recent financial crisis, the Bank has cut interest rates aggressively, by 2% in the last 2 months, to stimulate growth in the ailing British economy.

Influences

The UK is a relatively high yielding currency and as a result, Sterling often suffers at the expense of the US Dollar when markets turn to risk aversion. Although the Pound and Euro are not technically linked the two currencies have historically tended to move together.

However, since 2006 this correlation has weakened. Stable British economy and government mean the Pound has been favoured as a relatively high yielding alternative to the Euro.

Future

The OECD predicts the UK economy will be one of the hardest hit of the G7 nations by the credit crunch. Financial turmoil, slumping property values and diminished export markets have significantly devalued the Pound and the UK economy has contracted by 0.5% in quarter 3 of 2008.

Revised GDP figures predict the economy will contract by 0.75 to 1.25% in 2009. In the aftermath of the market shocks in September and October 2008, the British government injected billions of Pounds into financial markets, bought preferential shares in major banking institutions, slashed interest rates and is set to lower taxes and VAT. The Pre-Budget Report detailed government plans to lift the country out of recession and the Pound strengthened internationally as a result.

However one major concern of the rescue package is spiralling government debt, which is set to top £118 billion pounds in 2010. This is compared to £20 billion from the previous financial year. High budget deficits are likely to make the Pound less attractive to investors but Darling has cited the 'exceptional circumstances' necessitating excessive borrowing.

Looking forward, this debt level could keep the value of the Pound low for some time as the government has to increase expenditure while simultaneously reducing its revenue through tax cuts. Economists predict we are likely to see the impact of recent government intervention in spring 2009 when there is likely to be an upturn in growth figures.