Foreign currency exchange: 7 things to think about in 2015

Looking back on an eventful 12 months for the currency markets, Matthew Harris shares his predictions for 2015

Deep impact

From a currency point of view, there have only been two talking points that had any major effect on the markets. The first was the ongoing recovery in the UK which most economists would now regard as complete – the size of the British economy as well as other factors such as unemployment are back where they were when things first turned south in 2008. The second point of interest was the Scottish referendum, which for a month leading up to the vote on 18 September caused fear, panic and general chaos throughout the markets, as well as in Scotland itself. This served as a timely reminder of how volatile currencies can be in times of political uncertainty, as a single opinion poll caused the pound to lose three cents against other major currencies when it looked as if there would be a ‘Yes’ vote. When the result came in, the pound hit the highest level in two years against the single currency. So what of the year ahead? Long-term predictions provide an excellent opportunity for forecasters to appear rather foolish, whether they are studying anything from the weather to, in this case, foreign exchange. Rather than looking to forecast an exact number for the exchange rate in 12 months time, I will outline some of the key events that are likely to affect the exchange rate over the upcoming year.

UK General Election

There will be a General Election in May, and the result is far from clear. We could see another Conservative-Liberal Democrat coalition, or a Labour-Liberal Democrat one; we don’t know how many seats UKIP will get, and there is still the chance that one party could get an outright majority. From a currency point of view, we look back to the 2010 election, when the rate swung back and forth by 5% on the day of the result as nobody knew what would happen next. While another hung parliament would not now be the unknown territory it was back then, it would almost certainly cause the pound to weaken, sending the rate down. For the rate to go up, the markets will be looking for the Conservatives or Labour to secure a majority. Given that markets also hate change, the best net result for the pound is, in theory, a blue victory. However, given the uncertainty and the volatility we saw in the run up to the Scottish referendum, it is likely that the pound will suffer across the board in the days and weeks before polling day.

UK interest rate rise

The next piece of news for next year will be the interest rate rise in the UK. This will be one of those that most readers both want and dread in equal measure. If you have a tracker mortgage, an interest rate hike will not have been on your Christmas wishlist. However, if you’re looking to buy overseas and will need to move money from sterling to euros to buy your new home, then a rate rise should be quite helpful.

If a country raises its base rate of interest, this is good for that country’s currency and in the vast majority of cases makes the rate go up. This is because it becomes more attractive for investors to put their money into that country. If you were about to invest money in a country, you would rather the interest being paid on that money was based on 1% than the current 0.5%. This better yield makes the pound more attractive, so exchange rates are likely to rise when the inevitable interest rate hike comes.

The eurozone recovery

Sooner or later, the eurozone will recover from its economic slump. In 2014, all major eurozone economies including France and Germany posted anaemic or even negative economic growth figures. Until we reach the point where economies start to recover, there remains virtually no chance of an interest rate rise. The European Central Bank could consider further economic stimulus measures such as quantitative easing to boost the economy. While these are ongoing, the euro remains weak and the exchange rate remains high.

Currency wars

One of the idiosyncrasies of economics is that countries do not want their respective currencies to be strong compared to others around the world. This is because it makes their homemade products more competitive, reducing their need to import and increasing the exports (and thus the money that enters the country). Throughout the recession, we have seen many countries, including Britain, take artificial measures which they knew would weaken their currency. We expect this to continue into 2015, with Mario Draghi’s comments to “do anything to defend the euro” attracting some interest. If the euro becomes weaker, the GBP/EUR rate will rise.

The big prediction

So with all that information, added to the vast array of data releases over the next 12 months, including but not limited to economic growth, unemployment, inflation, quantitative easing, retail sales and consumer confidence, the question still stands.

Where will the exchange rate sit next Christmas?

General wisdom among analysts suggests that the GBP/EUR rate will rise over the next 12 months, though progress is highly unlikely to be linear, and significant volatility is expected subsequent to any central bank action from either side of the Channel, and the strength of the pound will be particularly sensitive to inflation. In English, this means that although the rate is likely to climb, progress will not be a straight line upwards – there will be peaks and troughs. If we see any action from central banks such as an interest rate increase from the Bank of England or quantitative easing from the European Central Bank, there will be significant volatility after these events.

Making the most of the markets

As written earlier, although the rate is expected to rise throughout the year there will be a certain amount of volatility, so waiting as long as possible to arrange your currency does not necessarily mean that you will receive a better exchange rate.

There will still be plenty of opportunities for those both buying and selling euros to take advantage of any movement in their favour. You should ensure you speak to a specialist as and when you are expecting to need to change any funds and they can guide you through the markets,
and explain the pros and cons of each different trading strategy.

Matthew Harris is head of Private Client Services at Cambridge Mercantile

Tel: 020 7398 5700

www.cambridgefx.co.uk