LONDON -- The British pound is getting caught between the dollar's surge and the euro's slump, and its swings are shaking things up for businesses just as uncertainty grows over a potentially tight general election.
Caught in the crossfire of developments in the United States and the 19-country eurozone, the pound has dropped to a five-year low against the dollar but pushed to a seven-year high against the euro.
Against the dollar, it is trading below $1.50, its lowest since 2010, largely because of expectations that the Federal Reserve will start raising interest rates this year. Higher rates tend to bolster a currency's value.
At the same time, the pound has perked up against the euro as concerns rise over the eurozone economy that prompted the European Central Bank to begin a $1.2 trillion government bond-buying stimulus program. The pound this month rose above 1.40 euros to the highest level against the euro since the end of 2007.
For British consumers, the effect is straightforward: It will make summer holidays in the eurozone, such as the beaches of Greece and Spain, cheaper than before. At the same time, it will make any U.S. shopping spree more expensive.
On the whole, the British stand to gain as they travel more to Europe than they do to the U.S.
The pound's gyrations also may help households by delaying the moment U.K. borrowing rates start rising.
Because most British imports originate from the eurozone, the pound's rise against the euro means inflation will be lower than expected. Figures on Tuesday showed inflation at zero in February for the first time on record, raising the specter of deflation, a prolonged period of falling prices that can choke an economy.
That's why Bank of England chief economist Andy Haldane recently suggested the bank should not raise interest rates soon but rather cut them -- doing so could spark economic activity and raise inflation.
Though few economists think a cut is likely, the fall in inflation has eased expectations that U.K. borrowing rates will rise this year -- to the relief of mortgage holders as well as businesses.
Beyond the potential for lower interest rates, the pound's movements complicated for British businesses.
In theory, British exporters stand to gain in the U.S., where their goods will be relatively cheaper for consumers. Conversely, the same exports will become relatively more expensive in the eurozone.
The net effect is not even, though -- Britain's trade with the U.S. is dwarfed by that with the eurozone. In 2014, the U.S. was Britain's biggest export market at 12.7 percent. However, that was way short of the eurozone's collective total of around 45 percent.
So the economic pain of the pound's appreciation against the euro is set to more than offset any of the gains made in the U.S.
On top of that, the pound's fall against the dollar is likely to make companies' production costs rise since the dollar is used to price most commodities -- essential raw materials such as oil and copper. The pound's weakness, for example, means fuel prices are higher than they otherwise would be.
The situation is "generally an unappetizing and unfortunate mix" for British companies, said Howard Archer, chief European economist at IHS Global Insight.
Though the pound has been buffeted by developments outside its borders, its future performance could hinge on domestic matters.
The general election on May 7 is expected to be tight. Opinion polls show the Conservative Party, the main party in the current coalition government, is neck and neck with the main opposition Labor Party. Because no party is expected to achieve a majority, deals with smaller parties will likely be needed to form a government.
One scenario that could prompt volatility is the prospect of a referendum on Britain's membership in the European Union. The Conservatives have said they will hold one in 2017 if they form a government after the election. The small U.K. Independence Party may demand an earlier one if they end up propping up the Conservatives.
With many potential permutations, the uncertainty over Britain's economic course could cause further volatility in the pound -- and headaches for businesses.
"Political uncertainty is likely to continue to build in the coming weeks as the election campaign gets into overdrive," said Kathleen Brooks, research director at Forex.com.
Business on 03/25/2015