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Was that a soft summer breeze rustling through the pine trees? No. It was the sound of sterling plummeting against the dollar. The pound has fallen for the past 11 days against the US currency – its longest slide in 37 years. Since the end of July, it has dropped by 6.5 per cent to $1.86. How much lower might it go?
One answer is provided by technical analysis, those fiendish charts that foreign exchange traders like to use. They round off their estimates to the third decimal place and think, largely, in terms of interest rate differentials. Sterling overnight index swaps, or Sonia, suggest the slowing UK economy will see interest rates drop to 4.25 per cent by the end of next year. Tullett Prebon, an interdealer broker, believes they will continue to fall even further – to 3.5 per cent by the end of 2010.
With UK rates set to decline and US rates possibly rising, sterling only has further to fall. If the pound fails to stop its descent at $1.80, its drop could easily extend to $1.70.
Then there are fundamentals, those elusive forces that are supposed to guide long-term currency values. The key metric here is purchasing power parity. This is the idea that, after adjusting for exchange rates, an identical good will cost the same wherever you are. Here the prognosis is even more gloomy. Take the Big Mac, a yardstick of fair value popularised by the Economist magazine. Even after taking into account sterling’s recent fall, a burger still costs $3.57 in Chicago against $4.26 in London. To bring those prices into balance, sterling needs to fall to $1.56.
It’s not all bad news for travelling Britons, however. Big Macs are still more expensive in Europe. Indeed, the Big Mac suggests the euro needs to fall by 14 per cent against the pound before hamburger prices are equivalent. It may soon be time to cancel that transatlantic shopping trip to New York and book a train to Paris instead.
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