THE BLOG
14/07/2011 08:14 BST | Updated 13/09/2011 06:12 BST

Switch Out Of Sterling While You Still Can

Your bags should be packed. The swimsuit chosen, and a couple of paperbacks picked out. But if you haven't switched your pounds into a foreign currency yet, you still aren't fully prepared for the summer holidays.

Your bags should be packed. The swimsuit chosen, and a couple of paperbacks picked out. But if you haven't switched your pounds into a foreign currency yet, you still aren't fully prepared for the summer holidays.

The time to get out of sterling is now. The pound is heading for anther significant fall on the foreign exchange markets.

This week, sterling hit a 16-month low against the euro, and a five-month low against the dollar. But it has a lot further to fall. The weaknesses of the UK economy are getting more and more obvious every day. Already, figures from the Chicago Mercantile Exchange show speculators taking more positions against sterling than at any time since July last year. It is only a matter of time before the pound takes a beating on the markets.

There are four big reasons why sterling could face another 20% to 30% devaluation.

First, the budget deficit is going to get worse. The Office for Budget Responsibility is still forecasting growth of 1.7% this year. It isn't going to happen. Lower growth means less tax. The deficit targets will be missed. And countries with deficits that look out of control get punished by the financial markets - just ask the Greeks.

Second, interest rates are going to stay at 300-year lows for at least another year. The economy is still too weak to raise them. But they are going up elsewhere. Sweden just raised rates. The European Central Bank will lift rates soon. That makes other currencies look more attractive.

Thirdly, the crisis in the euro-zone has given the UK a free pass. The financial markets have been so busy trying to guess which of the euro nations will go bust next that they haven't had any time to focus on Britain. Another cobbled together rescue package for Greece will fix the euro for a few months. When that happens, the markets may look at the UK instead - and they won't like what they see.

Finally, there could be political instability ahead. Will the coalition last a full five years? No one really knows. The record suggests it may not. If there is one thing the foreign exchange markets hate more than anything else, it is a weak and unstable government. If that gets added to the rest of the point against sterling, the pound will plunge through the floor.

By the end of this year, sterling will hit parity with the euro. That will be a key psychological moment. And it will drop below $1.40 against the dollar.

That might be a good thing. The devaluation of sterling in 2008 after the credit crunch led to a modest revival in manufacturing and exports. The pound probably needs to fall again if it that is to be sustained - and the re-balancing of the British economy away from financial services is to gather strength. The UK needs to make more things and sell them abroad. But it will be painful. Inflation will rise even further. Counties that import as much as the UK can't devalue without having to pay more for what they import. It will mean a further cut in living standards in real terms.

Good or bad, it is going to happen. And whether you are an investor or a traveller, you need to switch out of the currency now.