Banking on the value of sterling

Having a bank account in dollars or some other foreign currency is one of the marks of the successful homme or femme d'affaires just as surely as a Rolex watch or a Gucci bag. It conveys an aura of sophistication and worldly wisdom, and easy familiarity with life and work abroad.

It can also be useful, for paying bills and drawing cash abroad and receiving payment in cash and cheques expressed in foreign currencies, without the tiresome and costly business of buying and selling foreign currency for every transaction.

More often than not, owning a foreign currency account has enabled account-holders to impress their friends with talk of successfully hedging themselves against a depreciating pound. But it does not always work that way.

The unexpected strength of sterling against the dollar, the mark, the yen and other traditional "hard" currencies has drastically reduced the value of money in foreign currency accounts held by UK investors in the last year or so by anything up to 25 per cent.

This trend could have some way to run because the pound is still strengthening in anticipation of increases in UK interest rates this year. Travel agent Thomas Cook is tipping the pound to reach $1.78, 8.85 French francs and 230 pesetas before the end of the year. Some experts think sterling could go even higher, which would further increase paper losses for UK residents holding accounts in foreign currencies.

But all trends come to an end and the time will surely come for shrewd investors to ride the return of the pendulum and make money on a bank account in foreign currency.

Holding hard currencies like dollars, marks and yen has, after all, been the right thing to do for most of the past half century, and it has been entirely legal ever since the whole structure of exchange controls was imperiously swept away by Mrs Thatcher and Sir Geoffrey Howe in the first few months of the new Conservative government 17 years ago.

Since then anyone with a few pounds to spare could open a bank account in foreign currencies either with a UK or foreign bank in the country of origin, or in offshore banking locations like the Channel Islands, the Cayman Islands, or the Bahamas. Even that was not strictly necessary when UK and foreign banks in London began offering investors the chance to open foreign currency accounts without even going abroad. Most UK and foreign banks in London will open accounts in a range of currencies.

But small investors may find that the image is less glamorous than the reality. Current accounts offer a cheque book and are ideal for paying bills and banking rent on foreign property, although if this is what you want it for, you need to be sure the bank you open your account with has a correspondent relationship with the bank your counterparty uses abroad.

In particular, if you want an account in one of the lesser currencies like escudos or drachmas it might be best to open an account with a bank which has branches in the UK and in the country whose currency you choose.

Most banks want a minimum balance of around $3,000 or the equivalent in other currencies, to operate the account without charge. For that you will not be expecting any interest. But if you choose a bank which will give you a cheque book and cash card, you can draw currency from your account whenever and wherever you are travelling in your chosen currency area, and if you make a lot of transfers it can still work out cheaper than buying and selling small sums of currency to meet each transaction.

It is also a valid alternative to using your credit card, which still leaves you open to unfavourable exchange rates when your account is debited.

For the same sort of sum you can open a short-term deposit account which will earn some interest . But to get a reasonable return you need something like $10,000 and to tie it up for up to six months.

It is important not to get carried away by the rates on foreign currencies which appear in most financial market reports. These refer to big sums in excess of pounds 1m-worth of currency.

Even now UK retail investors will be lucky to get 3 per cent on a US dollar account tied up for a year, 2 per cent on a Deutschmark account, 1-2 per cent on Swiss francs and less than 1 per cent in yen, compared with up to 6 per cent in sterling.

You will also have to buy the foreign currency to put in the account. That could swallow 6-8 per cent of the capital. If you are not deterred, almost any bank in the UK will open a currency account for you, in the UK or the Channel Islands or in the currency area you choose.

But you will usually do best with a bank with branches here and abroad, like Citibank for dollar accounts.