Pound tumbles against sterling

The pound has fallen to an eight-year low against sterling on the foreign exchange markets, in what economists believe may be a signal of a New Year sell-off.

The pound closed below 87p - at 86.70p against sterling - from 87.26p on Monday and at DM2.5725 from DM2.5826. This is its lowest level against sterling since April 1988 and is also a four-year low for the currency on a trade-weighted basis.

According to Mr Eoin Fahy, chief economist at Ulster Bank, the sell-off is the start of an ongoing process of selling the pound against all other European currencies.

He added that there are few reasons to buy the pound, except for importers who should now be buying forward. Otherwise it is simply a case of whether the pound will fall a lot or a little depending on whether or not the authorities decide to revalue the pound's central ERM rate.

In any case - according to Mr Fahy - if the markets were to drive the pound lower, the authorities would not revalue it above where it is trading at that time.

According to Mr Jim Power, chief economist at Bank of Ireland, there has been quite a bit of overseas selling and the pound is independently weak.

There are two reasons for the weakness, he added. The problems in South East Asia are keeping sterling supported and the pound looks too high, regardless of whether or not there is a revaluation.

Mr Fahy added that currency players can take a bet on whether the pound falls by 7 per cent between now and next summer or by 2 or 3 per cent. "Either way it is a one-way bet at the moment," he said. "I think we will see quite a bit more selling in the New Year."

He added that one reason the pound has remained well supported until now is a structural weakness in the currency over the last few months. According to Mr Fahy their only two conceivable scenarios where the pound could go higher. First if sterling went through the roof and the pound followed, or if the authorities decided there was such an inflationary danger that they would opt for a 10 per cent revaluation of the pound's central ERM rate. "Both are very unlikely," he said.

Over the next few months Mr Fahy sees the pound falling to either DM2.41 or DM2.51, depending on the policy option chosen relating to revaluation and the pound's entry rate into monetary union. At the same time it will decline against sterling, falling to around 83p with no revaluation or 84p or 85p following a realignment.

He added that a market-forced fall in the currency would take the pressure off the Government to revalue.

"If the currency were trading at DM2.50 there would be less scrutiny and less pressure from the Bundesbank and others to revalue," he said. "The lower we are trading the less the pressure both technically and politically."

He added that given the pound has declined from 105p to 87p without importing inflation there is little argument that another decline to 83p could have a significant affect.