Page last updated at 11:22 GMT, Thursday, 11 December 2008

Q&A: Strong euro, weak pound

A Paris cafe
Holidaymakers will find their pound does not go so far in Europe

The pound has touched an all-time low against the euro - meaning that the eurozone currency is now worth 97.7 pence.

Euro notes and coins were physically introduced in 2002, although the currencies of the initial 11 member countries were first joined in 1999 when their value was fixed in euro terms.

There are now 15 eurozone countries, with a total of 320 million inhabitants.

But why is the currency so strong now and what does it mean?

Why is the pound struggling?

Investors have been losing faith in the UK economy which now seems to be moving rapidly towards recession.

The trouble in the credit markets seems to have hit the UK harder than other countries, especially as the financial sector accounts for a bigger part of the UK economy.

And with consumers having borrowed heavily in the good times, and the government now facing a huge budget deficit, currency traders were in no doubt that the UK economy was in trouble and the time to start selling sterling had arrived.

Another reason is that the Bank of England has cut interest rates in the UK from 5% to 2% in the space of just three months.

Rate cuts generally encourage investors to switch to other currencies which have a higher rate of return.

Why is the euro doing so well?

Given the weakness of the pound, there has been a flow of money into the euro.

The euro is an increasingly attractive currency for investors compared with its rivals - not only the pound, but also the US dollar.

And the European economy, while showing undeniable signs of being gripped by the slowdown, is less burdened by debt than the United States or the UK.

The lower size of government deficits, the lower expectations for inflation, and the higher interest rates paid by the European Central Bank have also made holding the euro more attractive.

What will the impact be on people taking holidays in Europe?

Well, your pound will not buy as many euros, making things more expensive for you.

At one major High Street bureau de change, 100 euros now costs 99.11.

However as regular travellers between the UK and the continent will attest, the euro has been edging higher for some time.

But the price of a baguette at the boulangerie, an espresso on a Milan pavement cafe or a beer in a Spanish bar may come as a shock for anyone who has not been to Europe for a while.

The change has been quite dramatic. While a euro is worth almost 98p now, it was worth 71p at its physical launch in 2002 (and 57p on foreign currency markets during its all-time low in 2000).

But how about the broader economy? What will the impact be?

Overall, a strong euro is good for the UK economy.

It makes imports from the eurozone more expensive, while UK exports become cheaper to those paying for them in euros.

This should clearly be a boost to the UK manufacturing sector in these difficult times.

The eurozone accounts for about 60% of UK exports.

However, if the pound was to fall too sharply, it could lead to imported inflation, as the price of goods from abroad would rise.

Can we expect parity between the euro and the pound soon?

Some currency analysts are speculating that by the end of this year or early next year, we may be headed for parity, where one pound buys just one euro.

However, with the downturn set to grip continental Europe, others expect the euro will weaken.

One key factor is whether the Bank of England continues to cut interest rates more quickly than the European Central Bank.

Does the strength of the euro bolster the case for the UK to join the currency?

This argument is shrouded in politics and patriotism, as well as economics.

One drawback is that the European Central Bank's interest rate applies equally across all 15 eurozone countries, whether their economic growth levels are sluggish or breakneck.

But the euro has many things in its favour, especially when it is at such highs, by helping to keep inflation under control.

And while the dollar is gaining strength right now, even the former head of the US Federal Reserve, Alan Greenspan, has said that it is conceivable that it will one day "replace the dollar as reserve currency or will be traded as an equally important reserve currency".

There is also a strong argument that joining the euro would help lure more foreign investment.

And while many eurozone residents also expressed opposition to the euro when it was introduced, it is proving popular with citizens as well as business, especially those involved in cross-border trade.

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