Dramatic fall in sterling seen in coming months

Sterling will fall dramatically over the next 18 months and could even eventually enter monetary union at above parity against the pound, a leading economist has warned.

Speaking after a Citibank seminar yesterday, Mr Ram Bhagavatula, chief financial economist with Citibank globally, said his sense is the British establishment would like to enter monetary union at around DM2.45. He is predicting that sterling will fall to around DM2.75 this year, with a rapid decline setting in next year to bring it to DM2.45.

"Sterling is probably about fair value around there," Mr Bhagavatula said.

He added that Irish interest rates have probably further to fall than many here had been expecting. German interest rates will be around current levels at the end of the year or may have risen by one fifth of a percentage point to 3.5 per cent, he said.

That would mean virtually a 3 percentage point fall for Irish interest rates between now and the end of the year, as rates converge ahead of monetary union.

He added that there is a tussle between Ireland, Finland and Spain which could all do with higher interest rates as their economies are growing quickly and Germany, France and Italy which are doing badly, even under the current interest rate structure.

The challenge for the ECB will be to trade one off against the other. We have to think of the euro zone as a weighted average of the group. "Given the weight of the top four countries, the interest rate will be weighted more heavily in favour of the bigger countries which need lower rates. That will prove very low for Ireland and Finland."

Mr Bhagavatula is also dismissive of talk that the euro will be particularly strong against the dollar.

The euro and the mark will trade against the dollar in very similar ways and that will depend on the relative economic conditions in the US and in Europe, he said.

"There seems to be strand of thinking that the euro will be strong because there will be a huge switch of funds. But much of the switch will be from the 11 euro zone countries which will make little difference and, in any case, switching from central banks will not be an instantaneous process and will depend to a great deal on the behaviour of the US central bank, the Federal Reserve.

"If the Fed is serious about 2 per cent to 2.5 per cent inflation, I am not concerned about a big switch out of dollars."

He added that the Fed is likely to raise rates at its July 1st meeting as signs of inflation are now picking up.