Even if you didn’t spend your holiday in Europe this summer you’ll be aware that the euro has risen considerably against the pound in recent years. As a general rule, weak or weakening economies will tend to see their currencies depreciate. But, with many of the eurozone’s peripheral economies on their knees, the resilience of the euro against both sterling and the dollar seems to go against this conventional wisdom.
So why is the euro appreciating? The industrial prowess ofGermany, which boasts year-on-year growth of 4.9 per cent is one cause. The demand for German luxury goods and brands such as Mercedes and Hugo Boss is strong. Meanwhile, in theUK, lacklustre exports have contributed to subdued demand for sterling. Another important consideration is the interest rate differential. The Bank of England has kept rates at lows of 0.5% in theUK, while the European Central Bank (ECB) rate sits at 1.5%. This rate makes euros look more appealing to investors than the countries with lower interest rates.
However, it seems reasonable to suggest that these factors will not be sufficient to support the euro indefinitely. Not only are many eurozone countries saddled with huge debts but their deficits – how much more their governments spend each year than they raise in taxes – are also rising. Cutting public spending is obviously the answer. But a reduction in public spending removes what has been a significant driver of economic growth in recent years. This makes servicing and paying down debt even more difficult.
There has been much debate about whether increased European integration – both financial and political – is the solution to the eurozone crisis. The question is whether voters will accept this and whether German taxpayers will contribute even more to the bail out fund. Furthermore, will the indebted, southern countries of the eurozone be willing to be told byGermanyandFranceto cut their public spending? Only time will tell.
Ashcourt Rowan does, of course, invest internationally on behalf of our clients and in that respect we factor in current expectations and issues related to sovereign debt. However, we gravitate towards our own domestic market when allocating assets, a so-called ‘home-market bias’. In the UK we are fortunate to have a diverse equity market and fund universe in which to invest. Many of the companies listed on theUKstock market are multinationals whose revenue streams originate from all over the world in a wide variety of currencies. As such, a relatively small proportion of our client assets are allocated directly towards euro-denominated investments and we are constantly monitoring our currency exposure here.
In our experience the paths that exchange rates follow are fairly random in the short-term, much like the stock market, and so there is little point in trying to base investment decisions on near-term currency expectations. Instead, we look at a currency’s valuation over longer timelines. Like any aspect of shrewd investment, issues such as currency fluctuations and sovereign debt require a considered, well-informed, long-term view.
September 2011