EUR/GBP Exchange Rates ... What's going to happen?

September 3, 2008 2:40 AM

I know very little about the money markets and exchange rates - does anyone with more knowledge than me have a reasonable handle on why the EUR/GBP exchange rate has jumped so much in the last year... And where it might stop?

My partner and I both earn in GBP and spend in EUR. This chart shows pretty clearly that since we moved to Barcelona 4 years ago, our money has become worth far less. Recently, the rate seemed to stabalise but no it seems to be on the move again... What factors are affecting this? Why did it climb so much 6 months ago? What upcoming factors may come into play? And where might it end up?

posted by benzo8 to work & money (3 comments total)

There are a lot of factors that affect exchange rates but one of the biggest has to do with the moves of the country's (or the zone's) central bank. For example, since the US Federal Reserve has been standing pat or raising interest rates, the dollar has been strengthening vs. other currencies.

Here are the moves of GB's central bank:
http://www.bankofengland.co.uk/monetarypolicy/decisions/decisions08.htm
Euro:
http://www.ecb.int/stats/monetary/rates/html/index.en.html

However, based on the data (euro increased rates on July 9th and GB has lowered it), so part of the explanation is that the ECB has been increasing rates while GB has lowered rates by 25 basis points in April.

Another important factor is inflation, inflation in the Eurozone has spiked since the beginning of 2008 (check the chart on the right):
http://sdw.ecb.europa.eu/

Central banks combat inflation by increasing interest rates, so you'd expect the ECB to raise rates thereby strengthening the Euro.

I'm not a foreign exchange expert but that appears to be the culprit.

As for where it'll end up, who knows. Inflation did slip in Europe based on that chart so perhaps they'll hold rates again and things will settle down.
posted by wangarific at 4:41 AM on September 3, 2008

No one knows what's going to happen. If anyone did, they could make a fortune betting on it. Instead, what you get is lots of people betting and a market that represents a consensus of the bettors.

The exchange rate has been moving over the last year based almost entirely on expectations about interest rates. The UK seems to be sliding into recession faster and earlier than the eurozone, and the Bank of England has indicated that they are willing to cut rates to try to stimulate the economy. Meanwhile, the European Central Bank has kept to its longstanding reputation of being more sensitive to fighting inflation, and is signaling that they will maintain rates at their current levels despite the worsening economy.

The result is that investors are moving their money from GBP into euros, on the expectation that their pounds will earn less interest in the future as UK rates drop.

Historically, it's within the realm of possibilities that rates could move as much as 20% in the next year, in either direction. If you want to follow what's happening, you can read up on interest rate news every week for a year and you'll have a better idea of how currencies move in the short term.

If you want to protect yourself against the downside of another big drop in the pound, here are three possible strategies:
Hedging. Some banks offer guaranteed deposits that lock in the current exchange rate. I've seen La Caixa and HSBC offer deposits where you would make some money if the GBP-EUR rate improves, but not lose money if the rate worsens. These products are complicated and sometimes include hidden charges, so read the fine print carefully. You can do more efficient and sophisticated hedging by getting into currency futures, but I wouldn't recommend that unless you really know what you're doing.

Portfolio balancing. If you have some savings in GBP, you can distribute it evenly between pounds and euros, and reduce your exposure to another big drop in the pound.

Pound-cost averaging. This strategy involves changing a constant amount of pounds every month into euros, rather than a constant amount of euros. When the exchange rate is favorable, you'll be buying more euros, and when the exchange rate is poor, you'll buy less. If exchange rates move randomly, over time it'll even out to a better average rate. Although this strategy has been debunked when investing in a diversified portfolio that appreciates over time, it is still valid for currency movements, which should be a zero-sum game over the long term.
posted by fuzz at 5:14 AM on September 3, 2008

Thanks guys. Obviously, yes, I understand no-one can really know where things are going - my question was more looking for someone to be able to make a slightly more educated guess than my own "Down! Or Up! Or stay the same!"

Today the UK kept its interest rates stable and the foreign exchange rate gained a penny in our favour, so that all makes sense after what you explained... Cool. I do actually know a little more now!

The Pound-cost averaging thing sounds interesting, and eminently sensible, but it strikes me that if it's a zero-sum game, you need to start playing at least in the middle of the field - starting when things are at the bottom is not going to help much.

Hopefully we can ride out this current downturn and when things pick up, we'll look at some things to help us weather any future storms. At the moment, we'll just have to tighten our belts a little - us and the rest of the world...
posted by benzo8 at 2:04 PM on September 4, 2008