Predictions for Pound Sterling

Looking at Economics fundamentals, it is hard to understand why the Pound rose so much against the dollar in recent years. I think the main reason for the Pound’s strength is that it offered an easy alternative to the dollar, but, in looking for an alternative to the dollar the merits of the Pound has been exaggerated. With the UK economy predicted to slow down, it is highly likely we will see a general devaluation in the Pound, not just against the dollar, but also against other currencies such as the Yen and Euro.

The Dollar’s weakness has been well documented, but unfortunately many of the reasons for the Dollar’s weakness are shared by the Pound.

Why Pound is Overvalued

1. Current Account Deficit approaching 5% of GDP. A current account deficit means the value of imports is greater than exports, basically it means money is leaving the economy. If the UK, struggle to gain an equivalent surplus on the financial account it will lead to a devaluation.
2. Interest Rates set to Fall. Interest rates have a big impact on the value of a currency. Lower interest rates mean that it is less attractive to deposit money in sterling accounts and buy sterling bonds. The relatively high UK interest rates have been one of the main reasons for Central Banks and international investors being so willing to buy sterling. However, if interest rates fall this will no longer be the case.
3. Housing Market With house prices considered to be overvalued any fall in house prices in 2008 would slow down the economy and necessitate interest rate cuts to avoid recession.
4. Debt. UK government debt is approximately 38% of GDP (£486.7bn) However, this ignores Government promises regarding pensions. As the baby boomers retire the government will be faced with a large increase in demand for pensions, boosting government debt. Consumer debt is also at a record high. Boosted by a booming housing market, consumer debt levels have increased. High levels of debt mean that the economy has long term weaknesses and therefore it is hard to understand the Pound’s strength.
5. International Currency Reserve. The Pound accounts for 12% of all international currency reserves. It has been the choice for many Central Bankers after they have diversified out of the dollar. However, the reason for buying pounds has not been so much as a positive reason, but that it wasn’t the dollar or the Yen. It is likely Central bankers will no longer want to increase their exposure to Pound Sterling given so much weakness in the Dollar.

The strength of the Pound is mainly due to the weakness of other curencies and investment opportunities.

Predictions for Pound vs Dollar

• Lehman Brothers say Sterling will drop to $1.68.
• Goldman Sachs forecast a 13% drop or more versus the Dollar.
• Morgan Stanley in summer of 2007 set “fair value” at $1.63.

Related

• Forecast for Pound Sterling 2008 
• Pound Sterling Predictions