Sterling has weakened again but the fall looks overdone according to Bank of Ireland

Sterling had a poor September, emerging as the worst performer of the major currencies. It fell by over 7% against the Australian and New Zealand dollars and by some 2.5% against the US dollar, but from an Irish perspective the most important depreciation was against the euro; the single currency had been trading in a 2 pence range either side of 86 pence in recent months but broke higher, briefly trading up around 93 pence at one stage. This was clearly bad news for indigenous Irish exporters, whose dependence on the UK export market is much higher than the aggregate trade figures would imply, according to Bank of Ireland’s October Bulletin published today, Friday 2 October 2009.

Author of the Bulletin, Dr Dan McLaughlin, Group Chief Economist, Bank of Ireland said: Currencies are volatile and short-term moves can be quickly reversed, so the issue is whether this bout of sterling weakness is likely to persist which in turn depends on the economic fundamentals. The UK’s economic performance has certainly been weaker than the euro areas, but not dramatically so: UK output has fallen by 5.6% from the peak, against a 5% decline in the euro area. However, both economies appear to have grown again in the third quarter, and the consensus expectation for respective growth next year slightly favours the UK. Similarly, the market is pricing in a more rapid tightening of monetary policy in the UK, with 3-month sterling cash at 2.35% at end-2010, against 1.85% from the euro. Moreover, the UK property market also appears to have turned, as we pointed out some months ago, with house prices rising on all the main indices, and the international banking system appears to be on the mend, which should be positive for the City of London.

“Yet the Bank of England appears to be much more uncertain about the economic outlook than the ECB and more mindful of the risks of deflation. The ECB is providing huge amounts of 12-month cash to banks at 1%, and is buying €60bn of corporate bonds, but the Bank of England is now committed to purchasing £175bn of government bonds paid for by printing money. A further extension of this money creation is certainly possible and some market participants expect the BoE to cut the rate paid on excess bank reserves to zero or close to that figure. Furthermore, the BoE is convinced that the UK economy needs to export more and consume less, and a weak currency would help in this.

“The perception that the UK authorities are not unhappy about sterling’s depreciation is no doubt an influence on the negative sentiment surrounding sterling in the FX markets, and traders have built up substantial short positions in the currency. Sterling now looks substantially oversold however, and the short sellers will have to cover back at some stage. Consequently, we still believe that sterling is fundamentally undervalued and will rally against the euro. The single currency also looks set to fall against the dollar and this too will help to pull the euro/sterling rate back to 88 pence in the coming months”, concluded Dr. Dan McLaughlin.


Contact: Anne Mathews, Media Relations Manager, Group Communications on 00 353 1 604 3836 / 00 353 87 246 0358