Cost of overseas travel soars as sterling drops 11 days in a row

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The Independent Online

For anyone about to travel abroad, August has so far been the cruellest month. The world's foreign exchange markets have opened for business 11 times since the end of July and, on each and every occasion, sterling has fallen in value against almost every major world currency.

After a high of $2 in late July, the pound has dropped consistently since the start of this month, dipping to $1.86 yesterday after the longest run of losses against the dollar for 37 years put sterling at its weakest level since 1996 against a basket of trade-weighted currencies.

There are two forces at work. On the one hand, the dollar has been rising as gloom, with regards to the US economy, gives way to the realisation that Europe may be even worse off. Official figures published on Thursday showed the German, French and Italian economies all shrinking in the second quarter of the year, which took the 15-nation single currency bloc to an overall GDP drop of 0.2 per cent. Meanwhile, on the other side of the Atlantic, the economy grew by 0.5 per cent, largely due to the impact of tax cuts. And while the pound remains broadly flat against the euro, the eurozone currency dropped below $1.50 this week, from a high of $1.592 in late July.

At the same time, just as the dollar is rising, the UK economy itself looks in a sorrier state. Mervyn King, Governor of the Bank of England, did not actually say the word "recession" when he presented the quarterly Inflation Report this week. But he did predict a year of "difficult and painful adjustment" and stagnation well into 2009. He also said inflation could reach 5 per cent before falling.

Although the interest rate is being held at 5 per cent, the suggestion of easing inflation was enough to raise expectation of a cut – pushing down the pound. "So we have the markets expecting the Bank to cut UK rates later this year, and also people expecting the US to come out of the slowdown before the UK and Europe," said Raj Badiani, a senior economist at Global Insight.

The US is reaping the benefits of proactive measures from both the government and the Federal Reserve, including lower interest rates and fiscally stimulating tax cuts, while the focus in Europe has been on rising inflation. "Mervyn King has only now shifted the focus to weak growth – so the market is anticipating a recovery over there faster than over here," said Mr Badiani.

How a weaker pound affects UK business and consumers depends on who you talk to. Exporters suffer from the added expense of currency exchange; for importers, the reverse is true.

But regardless of the benefits to some, sterling has dropped too far, too fast, according to the Confederation of British Industry (CBI). "The current situation is a double-edged sword," said Doug Godden, the CBI's head of economic and fiscal policy. "A year ago, the feeling was that sterling had been overvalued for the best part of a decade, so a gentle decline would be welcome to help rebalance away from such strong reliance on consumer and government spending, towards a greater contribution from exports and investment."

But taken alongside ballooning commodity prices, costlier imports are simply making matters worse, he added. And the sterling slide puts added obstacles in the way of future interest rate cuts.

It is not all bad news, however. The US is the biggest single contributor to the UK tourist industry – but the number of visitors from America, and how much they spend here, has been in decline as the strong pound pushed potential holidaymakers towards cheaper, emerging economies such as India and China. In 2006, there were 3.9 million US visitors to the UK, spending £2.9bn. Last year, this was down to 3.6 million tourists, spending £2.6bn.