Sterling ‘may fall by 5% in value’

STERLING could fall by 5% in value against the euro before the end of the year, Ulster Bank economist Niall Dunne said yesterday.

“The relative strength of the British economy and rising interest rates boosted demand for sterling over the past 18 months, but if British economic growth is set to slow as nervous consumers spend less, then it seems likely that the pound will fall,” said Mr Dunne.

Ulster Bank’s forecast for a weaker pound is based on a revised outlook for British interest rates.

“The relative performance gap between Britain and the rest of the G7 is narrowing and as a result, British rates are probably at or near the peak for this current cycle. If growth slows to more normal, sustainable levels in 2005, then interest rates will no longer have to rise, yield differentials will narrow, and the pound will lose a key support,” he said.

“The pound is also likely to be weighed down by deficits going forward, since Britain is burdened with a substantial trade deficit, and as we’ve seen in the US in recent months, trade deficits tend to drag on currencies,” Mr Dunne argued.

Ulster Bank also examines the impact of the British general election on the pound, and argues that sterling looks set to weaken irrespective of the vote.

“The result of the election is a foregone conclusion, but the market is nervous, not over which party will win, but over what majority the Labour Party will win by. It’s the possibility of a weaker Labour victory that’s troubling,” he said.

Mr Dunne warns that a reduced Labour majority could lead to a leadership contest or indecision on policy direction, both of which would negatively affect British growth. “Such uncertainty would affect the perceived stability of the pound,” comments Dunne, “and sterling would likely weaken under such conditions,” he said.

“A decisive victory could encourage the chancellor to raise taxes in the next fiscal year, as virtually all independent commentators agree he must. Higher taxes would affect growth, and the pound would hardly rise in an environment of rising taxes and falling interest rates.”