How to make your pound go further

The pound in everyone's pocket has been worth less and less over the past year. At home, rising inflation has meant we've been forced to spend more of our pay-packets on essentials such as food, petrol and heating. And when we travel abroad, a sharp collapse in the value of sterling has begun to make trips to almost anywhere much more expensive than they were a year ago.

In the past 13 weeks alone, the pound has slumped from being worth almost two US dollars to less than $1.60 – meaning trips across the Atlantic are now 20 per cent more expensive than they were in the summer. Meanwhile, the euro has continued its year-long rise against the pound, hitting new, record, highs of €1.23 during the past week.

Whereas 10 years ago, tourists in Spain couldn't help remarking on how cheap everything was, you are now lucky to find yourself paying any less for a meal in Barcelona than you would in London. Sadly, when it comes to the weakening value of the pound, the worst may not yet be over. Although the currency markets had been expecting Thursday's Bank of England interest rate cut, further rate cuts are expected over the months ahead. And when rates are cut, the less investors want to hold our currency, which means its value deteriorates even further.

Value to be found

But while the pound has been having a rather difficult time, there are a handful of currencies which have been faring even worse over the past few months, and now look that much more attractive for British travellers who are looking to take a holiday overseas this winter, or hope to partake in some good value Christmas shopping.

Iceland was one of the most expensive countries in Europe until it was engulfed by the banking crisis. Today, your pound will go 25 per cent further there than it would have in the summer. In mainland Europe, countries such as Serbia, Poland and Hungary have also seen their currencies depreciate by up to 10 per cent against the pound recently due to the credit crunch. Or, if you're looking for warmer climes, the Australian dollar and Brazilian real have also deteriorated significantly.

Mark O'Sullivan, the director of trading at Currencies Direct, says that the places which are now much more expensive are the US, and all the many countries whose currencies are pegged to the dollar, such as the United Arab Emirates' dirham. The Japanese yen has also soared against a number of currencies – including the pound over the past month – and is now at nine-year highs of less than Y160 to the pound. Tokyo was already an expensive city, but trips to Japan at the moment may feel financially crippling.

Remember that if you're going on holiday, the cheapest way to manage your foreign exchange requirements is usually to spend on your credit card – and pay off your balance in full on your return. But before you leave, it's worth double-checking that there are no charges levied on your card for transactions abroad. And avoid withdrawing cash with your credit card – as almost all cards charge a hefty fee for this. The cheapest way to withdraw cash is usually using your debit card – but try to make as few withdrawals as possible, as there will almost certainly be a fee here too, though not as much as with a credit card.

If you want to physically exchange currency before you go, the best rates are to be found online. Travelex (www.travelex.co.uk) guarantees that it will give you the best online price, and allows you to pick up your currency at one of its airport branches before you fly.

Reduce your exposure

For some people, currency exposure has much more serious implications than merely increasing the expense of their holidays. For British staff who are paid their bonuses in foreign currencies, or those who own property overseas, sharp currency movements can make or lose them thousands of pounds.

It is, however, possible to reduce your exposure to currency moves by locking in a particular exchange rate for a fixed period. Companies such as Currencies Direct (www.currencies direct.com/uk) and HFIX (www.hfix .co.uk) allow you to lock in an exchange rate for periods of up to two years.

So, for example, if you own a property in Spain and receive a monthly rent in euros, you may decide that it is in your interests to lock in the current exchange rate – which is at all-time highs. By buying a forward contract, you would be able to continue converting your money back into pounds at the current exchange rate for the next year or two.

Houses such as Currencies Direct tend to offer free transfers for sums over £5,000, but will charge a £15 fee to transfer sums that are any smaller than this.

You can also make use of forward contracts if you're thinking of buying a property abroad in a few months, and are worried about the exchange rate moving against you in the meantime. For a deposit of around 10 or 15 per cent of the sum that you'll need, you're able to fix the rate for the whole transaction up to two years in advance. Mark O'Sullivan believes that 2009 will probably see a strengthening in the pound against the euro, so says that now could be a good time to fix. "I think you're going to see sterling move higher against the euro as the European economies struggle over the coming year," he says.

Take advantage

Although the pound has been weakening in recent months, currency movements don't have to be bad news. Over the past few years, British investors in US mutual funds have seen their investment returns seriously eroded by the weakening dollar – but now this position has been reversing, the UK value of the shares held in these funds has significantly increased. So, for example, while the US stock market fell by around 14 per cent in October, the Legal & General US index trust, a UK-based US tracker fund, fell by only 6 per cent – because the value of the dollar increased.

Even British-quoted shares may benefit significantly from the weakening of the pound. For exporters, a weak pound is good news because British goods are cheaper – and therefore more attractive. Equally, firms such as GlaxoSmithkline or Diageo, who make a large proportion of their profits in the US, will benefit significantly from the strengthening of the dollar. If you have heavy exposure to one currency in your investments, and want to protect against moves which will erode your returns, it is possible to hedge your position, using instruments such as covered warrants or spread betting.

However, if you're a sophisticated investor, you could go one step further and speculate directly on movements in the currency markets. Again, you can trade currency covered warrants, offered by the likes of SG (uk.warrants.com), which move up and down in value at a much faster rate than the underlying currency shifts. Alternatively, it's possible to open foreign currency bank accounts with banks such as HSBC and Citi, where you can hold large amounts of a particular currency on deposit, and trade it using a professional currency broker.

Shopping abroad? Watch out for the taxman

If you do happen to do some Christmas shopping abroad this year, be careful to not to get caught out by the taxman. Even at $1.60 to £1, many items in the US are considerably cheaper than you'll find them back home in Britain. But before you load up your suitcase with goodies, remember that you're only allowed to bring £145 worth of goods back into the country from outside the EU, before you're liable to pay VAT at 17.5 per cent, as well as import duties.

This limit is due to double to £290 in the near future – but it wouldn't be hard to bust even this limit with one big present-shopping binge. And the duties you'll pay if you exceed this limit are somewhat varied – depending on what you've bought. So, for example, women's clothing is subject to duty at 13 per cent, with the exception of underwear, which is only taxed at 6.5 per cent.

The good news is that many items, such as laptops and games' consoles – are not subject to any import duty. However, you will still be liable for VAT if you exceed that £145 threshold. And with exchange rates back down where they are, you'll probably find that once you've paid the taxes, you could have picked up your items for less at home. Which, of course, is exactly why the taxes are there – to ensure you spend your money at home, rather than abroad. Taxes also apply if you order items online from outside the EU – even if they're ordered as a present. For more information on import duties visit www.hmrc.gov.uk