David Karsbol, chief economist at Saxo Bank, looks at the causes and implications of the pound’s rapid fall against the euro
I think the euro is overvalued at the moment. Big job losses and insolvencies have already happened in the UK, but unemployment has not increased in the eurozone, at least not on an aggregate basis. That will come. The European banking system also has its problems – Eastern Europe is basically one big Iceland waiting to happen.
The European Central Bank (ECB) has so far been reluctant to take interest rates lower; they’ve been more focused on inflation. For some reason, the ECB does not expect inflation to decrease as much as the [Bank of England’s] Monetary Policy Committee or the US Federal Reserve. They’re about half a year to one year behind the UK, which has helped strengthen the euro against the pound.
Although a lower pound makes exports competitive, it’s not all good news as it leads to higher import prices. Because the UK is a net importer of goods, that naturally leads to higher inflation (or lower deflation), reducing the purchasing power of UK consumers.
Is the Bank of England’s aggressive rate-cutting policy sensible? Well, I don’t think this is a time to use words like sensible. It’s something different from what we’ve seen before. Personally, I’m against lowering interest rates: it’s better to take the pain in the short term, get rid of bad debt and take two horrible years of bankruptcies, then start all over again. But I’m not making government policy.