Reply To: £ drifting towards 1.31 Euro…



There is a big question here, and I’m not sure where it leads.

If Spain still had the Peseta it would have devalued heavily by now (inflation at 4.3%, big inflation differential with rest of Europe, massive current account deficit).

But because Spain’s currency is the Euro, it is actually appreciating against the pound. There are several reasons for this, and none of them have anything to do with Spanish economic fundamentals.

This is unsustainable. One of the following must happen at some point:

1. Spanish recession and prices fall through wage compression.
2. Spain crashes out of the Euro, goes back to the Peseta.

Either way, the Pound’s purchasing power in Spain is unnaturally low at the moment. One day it will rise, but how knows when. In the meantime, given the poor exchange rate, it makes sense to use as big a mortgage as possible to buy in Spain (thus partially reducing your exchange rate risk). Problem is, Spanish banks appear to have turned off the mortgage tap. The current account deficit means that Spanish banks depend upon capital from abroad to lend (current account deficit = capital account surplus, but you all know that), and now nobody wants to lend to Spain. Can’t blame them.