Page last updated at 16:25 GMT, Thursday, 13 November 2008

Sterling takes a pounding

By Katie Hunt
Business reporter, BBC News

New York skyline
Britons are likely to be making fewer trips to the US.

This time last year, bargain-hungry shoppers headed across the Atlantic to New York's swanky department stores in droves.

With the pound worth more than $2, they sought out cheap iPods, designer clothes and gourmet restaurants.

But few will be flying to New York to do their Christmas shopping this year.

Sterling has been one of the biggest victims of the global financial meltdown - losing more than a quarter of its value since July.

It has now fallen below $1.50 for the first time since 2002. The pound is also at its weakest level against the euro since the currency was created in 1999.

"People really aren't going to want to make international holidays," says Simon Derrick, chief currency strategist at Bank of New York Mellon.

'Worst recession'

Sterling's problems are linked to the wider economic picture.

The UK is expected to have the worst recession of all the G7 rich nations and this means investors think UK assets will perform poorly.

"Like everywhere, the UK economy is slowing down," says Daragh Maher, senior currency strategist at French investment firm Calyon.

Sterling has been like an elastic band that had been stretched too far and when it gave, it was vicious
Daragh Maher, Calyon

"But the perception is that we have over-borrowed more than other countries, so the payback will be greater."

Falling interest rates put further pressure on sterling.

Last week, the Bank of England delivered a shock one-and-a-half percentage point cut in UK interest rates to 3%, the lowest level since 1955.

Economists expect rates to fall further.

It means that investors get a lower yield on pound deposits and sterling-denominated debt, making them less attractive.

This could pose a problem for the government, as it is expected to issue debt to pay for the banking bail-out.

Falling fast

It is unusual for a currency to fall so far, so fast.

Only twice in recent history has sterling fallen by such a degree.

On 16 September 1992, the pound was withdrawn from the European Exchange Rate Mechanism, triggering a fall from around $2 to $1.40.

Blue Lagoon spa, Iceland
Iceland's financial crisis has made it more affordable for travellers.

Sterling fell by a similar degree in 1980 as a commodity bubble burst.

Mr Maher says that the pound at $2 was significantly overvalued and puts the currency's long-term intrinsic value at around $1.60.

"It's been like an elastic band that had been stretched too far and when it gave, it was vicious," he says.

Mr Derrick at Bank of New York Mellon says it is feasible that the pound could hit $1.40 in the near future and one euro could be worth more than 85 pence.

Winners

The fall in sterling could benefit manufacturers as the weak pound makes UK-made goods more competitive on international markets.

Similarly, overseas visitors may view the weak pound as reason to visit the UK.

"The recent fall in sterling and the approaching Olympics in 2012 give us a tremendous opportunity to promote Britain's attractions as a destination to the world, " says Tom Wright, chief executive of Visit Britain.

But, with the world entering an economic downturn, demand for UK exports and holidays may dwindle, as hard-up consumers opt to conserve their cash.

Comfort

For those planning to take summer holidays abroad, there is some comfort.

While the pound has weakened against most major currencies, particularly the dollar, euro and yen, it has held up against others.

Sterling has risen 10% against the Australian dollar since the end of June, as falling commodity prices have undermined the Australian economy.

And if you really want to maximise your hard-earned pounds, Iceland's financial crisis has made the notoriously expensive country more affordable.

The pound has gained about 25% against the Icelandic crown since the end of June, when Iceland's economy began to hit the rocks.

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