Should I buy euros now or will the pound get even stronger in 2016?
The pound hasn't been this strong against the euro since 2008. Is this as good as it gets? We ask leading thinkers in the world of finance
As thoughts turn to skiing trips or visits to holiday homes in Europe or further afield, it’s time to ask whether now is the best time to buy foreign currency.
In recent years the foreign exchange markets have been very volatile, with the pound appreciating dramatically against the euro but losing some of its value against the dollar.
These moves are being driven by strong forces at work in the global economy.
The key global trading blocs are all at different stages of their recovery from the financial crisis. As a result, they have different plans for interest rates, and other tools of economic control such as “quantitative easing”, also known as QE or simply money-printing.
These divergent strategies have a strong influence on where global investors such as pension funds and other institutions choose to put their money. It is the flows of gigantic sums around the world in search of the best returns that cause exchange rates to fluctuate.
Currently, this divergence in policy could be summarised as follows. America seems furthest down the road to recovery so is poised to start raising interest rates. It has already halted its QE programme. Britain is a little way behind, although interest rates are expected here within a year or so and our QE has also ended.
Europe is in a very different place. The economy is fragile and its recovery could be derailed by rising rates or a strengthening currency. Accordingly, the central bank wants to keep interest rates at rock bottom and the euro weak. To achieve the latter, more QE may needed.
Broadly, the consequence of this range of policies has been: dollar and pound strong, euro weak.
If things continue this way, the advice for tourists and other overseas spenders would be: delay buying euros for as long as possible, because it should continue weakening against the pound; but buy dollars as soon as possible before it strengthens further.
The outlook for the euro vs sterling
Marcus Brookes, a fund manager at Schroders, correctly predicted a year ago that the dollar would strengthen. He factors in currency movements when deciding how to invest money in his Diversity funds.
He said uncertainty around the vote on Britain’s membership of the EU, coupled with an improving economic picture on the Continent, might put the pound under pressure.
“Perhaps surprisingly to some, we expect that the period of euro weakness may be coming to an end, as the recovery there gains further hold,” Mr Brookes said.
But Rowena Macfarlane, a currency analyst at Standish, an American fund manager, said the European Central Bank (ECB) would need to devalue the euro further in order to generate inflation. Currently, the eurozone is close to deflation, whereas the central bank has a target of 2pc inflation.
Cutting interest rates tends to weaken a currency because investors take their money elsewhere in search of better returns. A weaker currency tends to generate inflation because imports become more expensive.
“The ECB mandate is to achieve inflation at or just below 2pc. In the near term, this means weakening the currency,” Ms Macfarlane said.
Pound vs euro since 2008 Photo: Source: NetDania / Moneycorp
What about the pound vs dollar?
The dollar has been king of the currencies recently, having been buoyed by a recovering economy and expectations of a rise in interest rates. When a country’s central bank raises rates, investors are attracted by increased returns and move some of their money to that country.
In this case, this would involve selling assets denominated in other currencies and buying dollars, either to hold on deposit in American banks to benefit from higher rates or using those dollars to buy other assets. Either way, the wave of dollar purchases pushes its value its up against other currencies.
Capital Economics, the London-based consultancy, said: “We have consistently argued that the US dollar is likely to keep rising against other major currencies.”
But not everyone expects US interest rates to stick to the widely predicted script of gradual rises.
James Harries, who manages Newton’s Global Higher Income fund, said any interest rate rises in America, the first of which is expected this month, would have to be reversed next year.
Such a sequence of events could see the dollar first strengthen, then weaken.
“US rate rises will have to be reversed,” he said. “In my view, the economy won’t recover and the threat of deflation will require lower interest rates and possibly even more QE.”
It would be unwise to commit to large purchases of foreign currency on the basis of these predictions. Paul Ashworth of Capital Economics said: “As anyone who has tried forecasting exchange rates knows, there is a (strong) possibility that we will be wrong.”
What The Telegraph's expert economics commentators say
Jeremy Warner
Jeremy Warner writes: The pound will inevitably strengthen further against the euro as the European Central Bank steps up its monetary easing.
But it will also probably weaken against the dollar, with the US Federal Reserve expected this month to announce the first interest rate rise since the onset of the financial crisis. Barring economic shocks, this US tightening cycle might persist for some time. However, this is already substantially priced into currency markets, as is further easing from the ECB.
Sell euros, buy dollars - or, for holidaymakers, buy euros as late as possible and buy as few as possible, and the opposite for dollars - has been the prevailing story for much of the past year. At some stage over the next 12 months it will switch, but not yet.
Ambrose Evans-Pritchard writes:
Anyone who needs to switch money from sterling into euros has a perfect window of opportunity over the next four months. The stars are aligned.
The European Central Bank is deliberately trying to push the euro even lower to fight deflation and light the damp wood of economic recovery. UBS, the investment bank, said the fire would ignite all too well by next spring. At that point markets will start to price in a policy pivot. The euro will come back from the dead. UBS has said it is 18pc undervalued.
By contrast, the pound is massively overvalued, held afloat by expectations that the Bank of England will be the first to kick off a fresh cycle of interest rate rises next year. Global capital flows are distorting the exchange rate.
Sterling is as badly out of kilter as it was at the peak of the currency bubble in 2007. It is even more overvalued against the euro given the higher accumulated inflation in the UK since the Lehman crisis.
Britain has the worst current account deficit in the developed world, now running at more than 5pc of GDP. The eurozone has a big surplus. Sooner or later, fundamental economic forces will bring the currency markets back to reality.
Act soon.
WATCH: The Telegraph's financial commentators will discuss tomorrow whether the euro can survive. Go to telegraph.co.uk/finance
Put a question to the experts: moneyexpert@telegraph.co.uk
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