A stronger pound is good news for expats who have more spending power overseas.
Sterling has seen a steady rise against other major currencies over recent months, and the signs are that as the UK economy outpaces recovery in Europe, the gap will continue to widen between the value of the pound and other currencies.
So far, the pound is around 9% up against both the euro and US dollar.
For expats, the good news also spreads further afield as both the dollars in Australia and New Zealand are falling against sterling.
Pushing the value of the pound up are the improving UK economy and general expectations on the money markets that Britain will be one of the first countries to put up interest rates.
This may be tempered against the latest Bank of England indication that interest rates are unlikely to rise before the May 2015 general election.
The Bank’s chief economist Andrew Haldane has suggested that rates may well stay at their present level for at least another year as stock markets and GDP growth around the world have taken a tough knock lately.
Investors have cashed in because of worries about the spread of the deadly Ebola virus and poor economic data coming out of the US and China.
The question for expats and foreign exchange traders is whether the pound is overvalued and can expect to fall back in line with other currencies.
Two tests are generally applied to check currency valuations –
- Purchasing Power Parity (PPP) – This calculates the buying power of one currency against another. Over 20 years, PPP suggests sterling is 3% over value against the euro and 11% against the US dollar.
- Trade weighted indexation – A comparison of exchange rates of major currencies computed against trading, which suggests over the last decade sterling is 15% above the previous high.
For expats, the picture seems to show the pound is punching a little above its weight, but not significantly so. Any realignment should not lead to any shock fall in value.
The pressure point will come if and when the European Central Bank triggers a quantitative easing (QE) program which kicked off the economic revival in the US and Britain.
Looking at the dollar/euro and dollar/sterling rates, some correlation between shifts between the dollar and euro have reflected in similar moves in the dollar/sterling rate.
That could mean if the dollar softens against the euro if QE bites in the single currency zone, some related movement could be expected in the dollar/sterling rate.