Exchange Rates, like equity prices, still defy modelling. If you could predict accurately the variables that drive the strength of currencies you’d be a very rich man, my son. Sterling , once a significant currency internationally, no longer is. There are only two global currencies and the Pound is not one of them.
After its crisis of a few years ago (teething pains) the Euro has become a very important currency with far greater stability and purchasing power than the Pound. Size is important and only the Dollar and the Euro offer the quantum that helps stability. There is no longer a “Sterling Area” of any significance – the Pound is just an internal mechanism of exchange within the U.K. and one that in respect of its Relative value is just a speculators’ plaything.
The rise or fall of Sterling is driven by traders’ actions – to go “Long” or “Short” on Sterling has little or nothing to do with the underlying fundamentals of the British economy. It’s a gamble on perceptions. The Pound falls or rises because traders see the likelihood of other traders selling or buying it in response to some event. Years of British political and economic mismanagement have seen the purchasing power of the Pound fall, unsurprisingly. This has been the collective response to a series of events that have lead traders to be bearish about the Pound.
Smart countries take the exchange rate out of the economic toolkit to reduce or eliminate the effects of speculation. Very large economies like Germany or France do this by being in the Euro. Well managed small economies (Singapore a good example) do it by having a fixed exchange rate with the Dollar. Britain goes it alone when logic dictates we should, of course, have been in the Euro from the start.
Traders love instability – they don’t mind if a currency goes up or down so long as they call it properly. Our Chancellor knows all about that! But whether this poacher turned gamekeeper can create stability in Sterling is highly doubtful in these times. Turbulence ahead – if you’re a fat cat get out of Sterling – the rest of us will have to hold on tightly for the ride.