In recent years, we have surveyed leading UK economists, fund managers and analysts asking for their forecasts on the economy and exchange rates for the upcoming year. These results enable us to produce our annual Sterling Outlook, which gives an insight into where the pound might be heading against the euro, dollar and other currencies. Free copies of our new Sterling Outlook 2015 are now available.
I appreciate hindsight is a wonderful thing but I always find it interesting to look back and see if things turned out as the experts anticipated.
Last year's forecasts for 2014 were impressively accurate. Over 68% of respondents forecast the dollar to strengthen dramatically against the pound to under $1.60 by the end of 2014; the rate currently stands at $1.57. On the other hand, there were some surprises with the pound making slightly stronger gains against the euro than many predicted - rising from €1.20 at the beginning of the year to €1.27 at the time of writing.
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The pound's performance was particularly strong over the first half of last year. In June, it climbed to a five-year high against the dollar ($1.70) on the back of strong economic data. Indeed, the International Monetary Fund (IMF) twice had to lift its UK growth forecasts, despite turning more cautious over the wider global outlook. At the time, there was much excitement surrounding hints from the Governor of the Bank of England, Mark Carney, of a possible rise in interest rates before the end of the year.
However, slowing inflation has clearly caught the Bank off-guard. It now seems likely Mr Carney will soon be writing to the Chancellor to explain why inflation is undershooting its target by more than 1%. The Bank is likely to see little reason to lift interest rates if inflation is falling, particularly in the absence of significant wage growth.
Euro zone struggles and US recovers
Fears of deflation and a string of poor economic data kept the European Central Bank (ECB) on the defensive throughout 2014. In fact, this led to it cutting its interest rates twice and even charging banks to hold deposits in an attempt to revive lending. Debate now turns to whether it will launch a fully-blown programme of quantitative easing involving the purchase of government debt, in the face of inevitable opposition from Germany.
Interestingly, the euro is now worth only slightly more than it was in July 2012 when Spanish and Italian borrowing costs rocketed. This forced ECB President Mario Draghi to respond immediately with a pledge to do 'whatever it takes' to keep the euro zone intact.
Meanwhile, the US economy recorded its best six-month stretch since 2003 in the second and third quarters of 2014, according to recent GDP data. Resurgent growth alongside steady improvement in the jobs market suggests a US interest rate rise might be around the corner. Accordingly, dollar strength saw the pound drop from $1.70 to $1.56 between July and November; the sterling/dollar rate is on course for its worst six-month performance since early 2010.
Given the potential for diverging central bank policies in the months ahead, we should expect volatility to remain a feature of currency markets. Risks to the UK recovery still remain in the form of high public debts, slow wage growth, weak export markets (notably the euro zone) and wider geopolitical tensions.
While Scotland's decision to stay in the UK temporarily lifted the pressure off sterling, May's general election will provide a fresh dose of political uncertainty. This volatility will be further exacerbated if it becomes likely no single party will win an overall majority.
In our new Sterling Outlook 2015, leading experts reveal what they think will happen to the pound, euro and US dollar next year. You can also read their views on interest rates, the general election and the factors they believe will most impact sterling in 2015.
Sterling versus euro and dollar in 2014
Data correct as at 1 December
Please remember past performance is not a guide to future returns
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