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Tuesday, 7 June 2011

Pound against the €uro: a handy guide to the state of the UK economy?

This morning, the FT foreign exchange rates show £1 at 1.12 €uros. Six months ago, it was 1.17 and I made a prediction then (on this Blog) that by end December 2011 that would be (roughly) unchanged. In other words, I reckoned (and still reckon) that whatever "crisis" the €uro goes through it will be no worse than the British crisis - so nothing much will change.

In general, I use the exchange rate as a rough guide to the state of the UK economy.

I know that the £ is falling right now partly because demand for sterling is damped by a belief that in the short term UK interest rates will not rise - and the short term is getting to be quite a long term. I still can't believe that until 2013 I have a mortgage at 2.99% - nearly 2% below the rate of inflation.

But the belief that interest rates will stay low is fed by the belief that the weakness of the UK economy - its refusal to GROW - will continue to be the central underlying problem, so significant that some inflation will be tolerated. (Inflation will be tolerated for other reasons - for example, it shaves the real cost of servicing government debt).

At the same time, the markets don't believe that UK demand for €uroland products will collapse, however expensive they become. How could it? The very weak UK economy simply does not produce the range of goods which €urope does - whether Spanish fruit and vegetables or German cars.

Shortly after it was introduced a decade ago, the £ reached a high against the €uro of 1.60 - yes, you actually got 1.60 €uros for a £. Those were the days when British pensioners emigrated to Spain for a life of cheap luxury, funded by converting sterling pension income into local €uros. Those were the days.

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