Sterling to strengthen in the coming weeks and has effectively joined the Euro

Sterling is set to strengthen in the coming weeks and is likely to trade at close to 66 pence against the euro, according to the latest Bank of Ireland Global Markets economic research bulletin.

Writing in this month's Economic Bulletin which was published today (Monday, 29th August 2005) Dr. Dan McLaughlin, Chief Economist, Bank of Ireland Group said that the strengthening of sterling will have implications for the Irish economy. He also indicated that sterling has effectively joined the euro.

"The euro's value against the dollar tends to grab attention, not least because it has proven volatile, moving in a 12% range, for example, over the last twelve months alone. However, the euro/sterling rate is much more important for the Irish economy. The UK is still Ireland's largest trading partner, taking some 20% of Irish exports and accounting for almost 30% of total imports. Moreoever, these figures understate the effective impact of any change in the euro/sterling rate, as the indigenous sector probably sells over half its exports into the UK market, and some two-thirds of Ireland's food and drink imports come from Britain. Fortunately, given this exposure to sterling, the euro has moved in a relatively narrow band against the UK currency for some two years now with periods of euro strength capped at 70 pence, and any sterling advance failing to push below 66 pence".

According to Dr. McLaughlin this 66 - 70 pence range coincides with sterling's old limits within the ERM before its exit in 1992. Fluctuation against the euro is in a low range and as a result the currency has effectively joined the euro.

"Sterling's central rate against the Deutschemark was DM2.95, broadly equal to 66 pence against the euro, and the lower band was DM2.78, which equates to just over 70 pence in euro terms. In that sense, the UK's relatively strong economic performance in recent years now allows it to trade back within its old ERM constraints, this time with the market intervening at the relevant limits instead of the Bank of England. So sterling can be said to have effectively joined the euro, or at least kept fluctuations against it to a 6% range, while moving further away from any formal membership of the single currency".

He concludes that movement within the 66-70 pence range appears to be strongly influenced by relative interest rates and on that basis he expects sterling to strengthen toward 66 pence.

"Sterling weakened sharply in July, for example, from 66.5 to over 69.5 pence, in anticipation of a series of rate cuts from the Bank of England. The latter duly delivered a quarter point reduction in August but the market is now giving a high probability to just one more quarter point cut, instead of the two previously priced in to the interest rate curve. Sterling has strengthened as a result, trading around 68 pence and may well move further towards the 66 pence lower band in the next few weeks".

Ends

For reference:

Dr Dan McLaughlin
Chief Economist
Bank of Ireland
Tel: 01 609 3326

Mary Brennan
Corporate Communications
Bank of Ireland Group
Tel: 01 604 3838

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