source: homes overseas magazine

Aggressive lending tactics on the part of some US mortgage companies came home to roost last year as American property prices continued their slide. Borrowers found themselves unable to cope with increased monthly repayments. Nor were they able to sell their homes for enough money to repay the mortgage. It was a problem for the homeowners but it was also a problem for the investors who had advanced the cash. Lenders became nervous about lending, investors became nervous about investing. The credit crunch that resulted is still with us and is a major factor in the economic slowdown that is happening now.

Sterling's position against the euro has been one of the main casualties in this financial turmoil and the tipping point was Northern Rock. The Rock was a sort of upside-down version of Ei Alamein: before Northern Rock sterling never had a defeat; afterwards it never had a victory. For four years the pound looked comfortable in a range that held it mainly between €1.40 and €1.50. In September, the queues of anxious depositors outside Northern Rock set alarm bells ringing, not just about the bank or the currency but about the financial system itself. Nervous investors did what they always do at such times, they sold stuff.

In this case they reduced their holdings of sterling. Sterling/euro was trading at €1.48 when Mr Applegarth of Northern Rock knocked on the Old Lady's door. A fortnight later it was down to €1.45, and that was just the beginning. Step by slippery step the pound stumbled lower, reaching its nadir in mid January at €1.32.

It was not solely Northern Rock that hit sterling on the head, the Bank of England also had a hand in the process. For the first half of last year markets had been under the impression that inflationary pressures would force the Bank to raise interest rates beyond their then 5.75 per cent level. The credit crunch changed that perception; how could the Old Lady raise interest rates when its commercial banks couldn't fund themselves without help? Instead of higher rates, expectations swung towards lower rates. Various publications and statements from the Bank and from its governor, Mervyn King, gave weight to the idea that sterling interest rates were heading down. Falling house prices seemed to make it almost inevitable.

Meanwhile in sunny Frankfurt, the European Central Bank (ECB) was blithely unconcerned about domestic problems in Britain or the States. ECB president Jean-Claude Trichet stuck to his mantra that the ECB must be vigilant about inflation. The message was that euro interest rates were still on the way up. This mismatch in interest rate outlooks added to the pound's discomfort. Sterling rates were going down (although they didn't actually do so until December) and euro rates were going up (in fact they never did).

Attitudes have changed since the turn of the year. Where previously investors pinned their hopes on rising euro yields they no longer do so, mainly because the ECB has at last come clean about the possibility of a slowing economy in the eurozone. The new catchphrase is "risks to the downside". The new expectation is that the next move by Frankfurt will be an interest rate cut, or two. At the same time, investors are no longer so ambitious in their expectation for rate cuts by the Bank of England. Base rates could be down to 4.75 per cent by the end of the year but they will still be appreciably higher than euro rates even if the ECB does nothing.

So, with this levelling of the playing field, we ought to be looking at a period of recovery for the pound. Sterling/euro has indeed been quite steady since mid-January. But will steadiness turn into recovery? That is a lot to ask in the current climate of nervousness and volatility.

For anyone planning to make a euro property investment later in the year the safe approach is to hedge your exposure. Classically this means buying now half the euros you expect to invest. It is a neutral strategy, neither a gamble that sterling will recover nor that it will fall. If you buy the euros for "forward" settlement you will only have to hand over a percentage of the sterling when you arrange the trade. The balance will only be required on whatever deferred settlement date you have chosen. With the exchange rate agreed on day one you know exactly how many pounds you will have to pay in total and exactly how many euros you will receive on settlement day.

Market uncertainty makes it equally as possible for sterling to go to €1.50 as it is to go to €1.20. Don't bet the house on which level it touches first.

The information in this article is for indicative purposes only and, while we believe it correct at the time of press, we disclaim all liability as to Its accuracy or any reliance you place on it. None of the information constitutes, nor should be construed as financial advice.