Predictions for Pound Sterling in 2010

The UK has experienced its longest post war recession, and the deepest since the Great Depression. Importantly, the UK recession has lasted longer than our main competitors. Whilst members of the Euro like Germany and France are experiencing positive growth, the UK remains stuck in recession.

The UK economy has suffered the most because of its reliance on the financial markets and an asset (housing) boom. The government and monetary authorities must be pretty dissapointed at the sluggish response of the economy. They have done as much as they can with fiscal and conventional monetary policy. Even the scope of quantitative easing is one of the most radical amongst Western nations. (though some commentators say by just buying gilts and not corporate bonds, the impact of UK QE has been diminished.)

Whilst other countries are considering raising interest rates, that looks a long way off for the UK. Any tightening of the economy will need to come from tax rises to deal with the burgeoning debt. (see: prospects for UK Interest rates)

Furthermore, despite a 20% depreciation in sterling, the UK retains a persistent trade deficit suggesting an underlying imbalance in the economy. Since the credit crunch there are less capital flows to finance a current account deficit. Therefore there we may need to have to be a further depreciation to boost exports relative to imports.

Another factor in the equation is the scale of government debt and the purchase of government gilts. This has potential to worry markets and raise future inflationary pressures.

Given these factors the prospects for Pound Sterling looks pretty grim. Low interest rates and quantitative easing will weaken sterling and the government’s fiscal position will not help. The trade deficit just adds to the gloom behind sterling.

The saving grace for Sterling may be the relative weakness of our competitors. The Euro is starting to look prohibitively expensive, at least for south European economies like Spain and Ireland. Though the Eurozone is emerging from recession, it still looks pretty weak. The ECB takes a fundamentalist approach to keeping inflation low, but, even the ECB will be hard pressed to justify rate increases with the Euro economy so weak.

The good news for sterling is that the worst may (hopefully) be over. Forward looking surveys on confidence show improvements. The recent rise in manufacturing output and car sales give hope a real recovery could materialise next year.

It is hard to make predictions because the current situation is exceptional with no real precedent. Alot will depend on the nature of recovery. If the UK’s growth continues to be weaker than our competitors sterling will continue its downward slide. But, if the UK grows quicker than expected and confidence is restored in the UK people may switch back to Pounds. But, overall, I think the most likely scenario is that the Pound will remain weak. Alot of us could be spending our summer holidays in old Blighty rather than paying to goto Euroland.