Why Fixed Exchange Rates have their uses

March 4, 2012 | By | 2 Replies More

You should consider fixing an exchange rate any time you know you are going to be making a large purchase in a foreign currency, e.g. buying a house or a boat. You can fix the rate up to a year in advance. The aim of doing this is to give you peace of mind, as you will know what the cost will be to you of your purchase, and your calculations will not be thrown if the exchange rate moves against you significantly between placing the order, or making an offer, and needing to complete the financial transaction.

Here is an example; Recently a friend of mine was moving back from France to the UK for work reasons. She had amassed a reasonable sum of Euros (90,000) to go towards a deposit on a house in the UK during her ten years working in France.

Buying a property overseas requires financial planning

Buying a property overseas requires financial planning and might involve fixing exchange rates in advance

When she made an offer on the house she wanted to buy in the UK the GBP/EUR exchange rate was sitting at around 1.15, but within 2 weeks (on the back of some very poor economic news from Europe) that rate had climbed to 1.17, meaning her deposit monies were worth £1,336 less.

Over a Sunday lunch this friend and I discussed her purchase. She was hoping that the exchange rate would decrease again to 1.15 before she had to exchange, meaning she would get more £s for her Euros.

However all the economic news coming out of Europe at that point was bad. There was (and still is) the threat of the Greeks defaulting, and the Euro zone growth figures for the next year were negligible if not negative, meaning a recession was knocking at the door. I felt that the rate would very likely not go back down to 1.15 in the foreseeable future, and urged her to fix her exchange rate the very next day for all her deposit monies. She was not keen to do this, believing that as it had only been two weeks since the rate was at 1.15, then surely it would go back down there again at some point between now and her needing to exchange.

I then suggested that she should protect herself against further negative moves in the exchange rate by setting a minimum at which she would be willing to do the trade. So if that exchange rate was hit then her deal would automatically be placed. She might not get the exchange rate she was hoping for, but she would know in advance her absolute worst case scenario.

She did neither of my recommendations, preferring to sit it out and wait and see what happened to the exchange rate. She had two months before exchanging so there was plenty of time. However the exchange rate continued to move against her, and although she tried to stretch exchanging for as long as she possibly could, she eventually had to settle at a rate of 1.190, a further total fall of £1,292 in the value of her Euros.  She therefore lost a total of £2,628 in a couple of months by not fixing her deal in advance.

As I write this (4th March 2012), the GBP/EUR exchange rate still sits around 1.1930. It briefly fell back to 1.18, but it has never reached 1.15 over the past 5 months, and many exchange rate forecasters now believe that 1.18 will be the new baseline for the GBR/EUR exchange rate.

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Category: Currency news, Property

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