Discuss and analysis the movements in value of the Euro against the pound since January 2008
Introduction
The value of Euro varies with time by a floating exchange rate against British Pound (GBP). Hence, the exchange rate influenced the value of Euro against GBP and law of one price is assumed. Theories such as the relative Purchasing Power Parity and the fisher effect illustrate the impact of the inflation and the interest rate between two countries on the value of the currency. The asset market model is also another instrument to analyse the movement of a currency. The constraints of using these models are those theories all assumed perfect efficiency of market and the increasing role of global capital flows is ignored. Therefore they are relatively useful to predict the rates in the future which are demonstrated in part two.
The following analysis is based on economic factors such as the economic status of the Euro area and the United Kingdom (UK) and the decision made by the Bank of England (BoE) and the European Central Bank (ECB). The investor confidence (Market Psychology) is also below. They affect the value of euro significant, as they vary the supply of and demand for Euro.
The value of Euro against British Pound (GBP) increased throughout the three years. The Euro rose from 0.7416 to 0.8507 over the three decades. Euro was 0.7416 at the beginning of 2008, which was its weakest point in these three years. Moreover, the strongest point of Euro relative to GBP is 0.9785 on December 2008. In general, the Euro against GBP has rose significantly at the end of 2008 but depreciated from 2009 to 2010.
The rate of EUR/GBP 2008-2010
The table below illustrates the movement of Euro against GBP throughout 2008 and 2010. We represented the trend as Euros/GBP ratios. (Fig1)

(Scorce: European Central Bank Fig1)
The graphs below, figure2 and figure3, illustrate the inflation rate throughout the three years, they show that both the EU and the UK have similar pattern.

(Inflation in the euro area Fig2) (Inflation in the UK Fig3)
2008
The world economy was dragged by the financial crisis in the USA and Iceland. In contrast to the Euro area, the UK had suffered more.
The Euro was at 0.74, its weakest point at the beginning of 2008. The reduction of interest rate announced by Bank of England and the UK debt level which was greater than 40% of GDP made the value of GBP depreciated significantly and dropped by 27% (Fig 4). The inflation rate of the Euro area and the interest rate of the UK affected the value of Euro. The inflation rate of EU dropped to 1.6% (Fig2), whilst the UK’s rose over 3%. This made the euro exports unattractive. However, because the UK had the similar trend in inflation (Fig3), the overall effect was then offset in the beginning of 2008. This explained the reason why the movement of Euro was fairly constant from April to October. The value of euro has maintained at the range of 0.7901 to 0.8130.

Source : ECB, Annual Report2009 (Fig4)
According to the Interest Rates Review 2008, as the Bank of England tried to counteract the widespread credit crisis on the housing market, the interest rates cut by a quarter of a point to 5% and dropped further towards the end of 2008. The interest rate of EU, 6.5% was relatively higher than 5% which caused more hot money to flow into the EU economy. As the demand of Euro increased, the value of Euro appreciated. Nevertheless, Euro did not have radical increase in value. The effect was offset by the decline in German retail sales and the performance of the French Trade Balance.
The value of Euro rose 26.26% from 0.7751 to 0.9785 from October to December2008. The rise in value of euro was caused by the chain effect of the credit crunch, the crisis of Iceland and the relative low interest rate of the UK. The Credit Crunch has brought the world economy into recession as the US economy has a huge effect on the world economy. The Iceland financial crisis has worsened the economy of the UK. This is because more than 100 UK local authorities such as the council of Kent and Transport for London had invested over £840 million cash in the three major Iceland Banks. The collapse of the banks in Iceland damaged the economy across the UK which led to a depreciation of value of GBP. In contrast, Russia has granted Iceland a EUR 4 Billion loan. Iceland was considered to join the European Union. These boosted the demand of Euro which drove the value of Euro rose to the highest point 0.9786 toward the end of year.
In addition, the inflation rate of EU dropped to 1.6% (Fig2), whilst the UKs rose over 3% at the end of 2008. This drove the value of Euro to the highest point 0.9786 toward the end of year. EU experienced a lower inflation rate relatively to the UK. Importers from the EU became more prices competitive with the UK.
2009
GBP fell after the figures added to growing expectations that Britain would face a lengthy recession and the announcement about the low interest rate 1.5% made by the Bank of England. The Euro area and the UK both still faced the economic depression. The value of both currencies moved in the same direction. The value of Euro against pound did not fluctuate and managed to stay within the range of 0.884 to 0.918. Nevertheless, the fall in value of pound made exports to the United States and the rest of Europe less expensive.
With the improved business sentiment in Germany, the EU market confidence was boosted and the UK economy recorded the sharpest contraction in 30 years during the first three month, the value of Euro against GBP soared to near 0.91 on March/April. However, Euro then experienced a fall in value from April to June.

As mentioned above, both countries were facing recession, Euro only fell 5% of its value in March. This is explained by the debt crisis of Greece and the situation of the UK. The inflation of UK was creeping up, the quantity of goods and services were less demanded as prices increased. The budget deficit of UK was slightly higher than Greece. The UK private debt was 1.5 trillion GBP which was the highest in the world. However, the UK monetary independence means that they can deflate its debt by printing more money. Greece was supported by the International Monetary Fund which pushed its bailout to 45 billion euro. Also the Euro Zone agreed on a 30 Billion Euro rescue package to Greece. The overall effect led to depreciation of the value of Euro, whilst the value of GBP increased slightly. During the second half of the 2009, the value of Euro started to clawed back to the 0.9 level. This was mainly due to the improvement of the German manufacturing sector. This is also related to market efficiency. Germany and France both posted favourable reports indicating that they are “wealthiest countries may be found their way out of recession”. As Germany and France are the major economic of Euro Zone. Increasing the manufacturing and services produced by these two countries could make Euro more competitive against GBP.
2010
The value of Euro dropped by 12% on first half of the year but managed to rise to 0.8873 by 8.1% toward the October.
The movement of the Euro was greatly affected by the Debt crisis in various countries in the EU, Greece, Spain, Portugal and Italy. They brought about long term influences throughout 2009 to present. The fluctuation during the beginning of the year2010 can be explained by the announcement made by the European Central Bank on Jan 14.
“the region’s economic outlook remains uncertain and policy makers would not rescue Greece as the country struggles to reduce its budget deficit.”
The austerity measures in Greece, Portugal, Spain, Italy and Ireland began to weigh heavily on economic growth. This dragged the Euro zone back into a period of stagnation. This affected the investor confidence in Euro and in turn the value of Euro fell during March to June.
In the bond market, which acts as a very clear indicator of market sentiment towards sovereign debt, the yields on Greek bonds remained high (Fig5). This raised the flow of Euro to other bonds in other countries, such as English bonds. This led to resumed selling of the euro. Hence, the fall in demand of euro therefore led to a decrease in the value of Euro. However, the fall in Euro against GBP created an opportunity for those who are risk loving. Expected return and risk are positively correlated. The volatility of the Greece Bonds could attract funds to flow back to the EU. This could help stabilise the Euro and drive down the bond yield for Greece during the economic downturn in the Euro Zone. Euro was still not attractive for the investors, as it was still classified as a risky bet. The value of Euro remained less competitive than GBP.
Furthermore, the relative weakness of the Euro gave the Euro area a sizeable injection of cash through the tourism industry during the period from June to August 2010. This reduced the downward pressure of the Euro for a short term. However, further investigation on the impact of the injection of cash through the tourism industry is required.
Towards the end of the 2010, the Euro was strengthened. The Euro performance in the FX market was a far cry from investor sentiment towards Euro bonds. The appreciation of the value of Euro can all generally be explained by the fact that “risk is on” during the late 2010, and the markets were moving away back towards growth investments. At the moment, risk appetite is high and the Euro symbolizes risks. The growth in the EU was projected at 1.8% for the year while Rest of World GDP will probably top 5%. All that matters is when to GBP, the Euro is perceived as the currency of risk.

(fig5)
Conclusion
The demand for and supply of the Euro affect the exchange rate of Euro against GBP, thus the value of Euro affected by the exchange rate of Euro/GBP. Factors which affected the demand and supply of the Euro throughout these three years were used to analyse the movement of value of Euro.
Because of the Crisis throughout the three years which the Euro area had faced, the ECB has decided to maintain the fiscal austerity. While the Central Banks around the world were competing with each other to devalue their currencies, the ECB decided to remain on the sidelines in order to accompany its fiscal policy. In contrast, the value of Euro against GBP has strengthened.
The overall value of Euro was increasing within these three years. The most radical move happened at the end of 2008 due to various factors which are the Credit Crunch, the Iceland financial crisis and the change of inflation and interest rate in both the Euro area and the UK. The effect of the crisis had a greater impact on the fluctuation of Euro than the indifference of inflation rate between the Euro area and the UK.

References
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