Let’s have a look at the latest news out of Europe. The European Central Bank announced it would purchase up to €600 billion in government bonds. That move is supposed to help bolster the economy and prevent further weakness against the US dollar and the Euro.
But let’s not forget the British Pound. The U.K. is in the process of exiting the European Union and will soon be trading with both the Euro and the US Dollar. This makes it harder for the British to trade with each currency as effectively as they could.
The fact that it is harder to trade with strong currencies is not necessarily a bad thing. Strong currencies make it easier for international trade. People who live on a tight budget often look at the cost of international trade to determine how much money they have to save and apply for a loan.
The increased cost of trading with the US Dollar and the Euro means that many people are unable to save as much money as they otherwise might. That can result in the downward spiral of a situation where the cash they have comes from savings and not investing. They put all their money into the bank and are later unable to access it.
That means it makes it harder for the UK to buy imports. The U.K. now trades with both the Euro and the US Dollar. That makes it harder for the Pound to weaken against either one of them. If the U.K. wants to be successful in these upcoming years, it has to use its currency to buy imports from the Euro and US Dollar.
It is this end of the equation that makes it difficult for the British to use the British Pound to buy foreign goods. That makes the United Kingdom different from most other countries in the world. Most other countries, except for the U.S., actually trade with the Euro and the US Dollar together.
It also makes it difficult for the Euro and the US Dollar to strengthen. So instead of the Euro and US Dollar strengthening against the British Pound, it often weakens against both. That causes the British Pound to weaken against the Euro and it often stays that way.
The Euro was already weakening against the Pound as early as July of last year. Now that the British are leaving the European Union, the Euro is strengthening against the Pound. So, in the near future the European Central Bank will almost certainly need to buy Euro-denominated government bonds in order to get the economies of Italy and Spain to stabilize.
And the Euro is still weaker than the Dollar and the British Pound. It may take even longer for the Euro to get back above parity with the British Pound. So while it is better to trade with the Euro, it is still a trade that is difficult for the British.
What makes the situation even more difficult for the British is that some of the Euro-denominated bonds are backed by the German Bund. If those bonds don’t perform well, then Germany could pull out of Europe. That could put pressure on the German government to de-back its currency.
When that happens, the Euro and the Pound would likely appreciate if it doesn’t do anything and the ECB starts buying Euro-denominated bonds. The British would need to be able to sell their goods and services internationally to remain competitive. Now it may be hard for them to do so as the Euro strengthens against the Pound.
The problem for the British is that they could do little about it. Their government has yet to issue another bond in Euros. So while they can no longer trade with the Euro as effectively as they once could, they cannot do much to affect the value of the Euro itself.