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Cast your mind back to that surreal period just after Brexit. Remember how discombobulated you felt? Leaderless Britain, Tory party turmoil, the spectacular Boris and Gove fallout, England losing at football to Iceland? The pound was in turmoil too. It fell about 11 per cent.
Actually, that was pretty much expected. Virtually every economist said it was going to be sold off because no one knew what Brexit really meant for the UK economy, so the assumption was it would be bad. The next bit of the summer was not expected — the economy stayed in surprisingly good shape, fears of a post-Brexit recession were put to bed, so the pound rallied.
Now, sterling is falling again — by nearly 5 per cent this week to its lowest level since the referendum, which is also its lowest in more than 30 years. Why? Because Theresa May, in her speeches at the Conservative party conference, dispelled any idea that the UK was going to backtrack on Brexit and revealed a deadline for setting the divorce process in motion. The currency market took that to mean that the prime minister was angling for a Hard Brexit — a view reinforced by some trenchant rhetoric from the PM. European leaders agreed and markets resumed their negative post-referendum mood.
A so-called “ flash crash” at one point dragged the pound down to $1.18 and though that fall has largely been unwound, the pound has ended the week in a weary, battered state. “Error or not, the reaction illustrates that the British exit from the EU has the potential to create considerable disruption on the markets,” says Commerzbank’s Lutz Karpowitz.
Who are the winners and losers?
Foreign tourists are big winners. They flooded the UK in the summer after the big post-Brexit sterling drop, and if they can brave Britain’s weather, they will do so again the next time they have a break.
So UK tourist attractions, and other parts of the leisure industry such as restaurants and hotels, also benefit.
Other winners are anyone in a hurry to sell a UK asset, such as a house or a company. Foreign buyers may never get a better opportunity. Exporters now have more competitive goods to sell. And hedge funds always like a bear market.
The losers? Brits going abroad. Summer holidays in Europe and elsewhere were painfully expensive and will be more so now, making the idea of staycation holidays more tempting.
Car drivers face higher forecourt prices because the UK is a net oil importer and the price of a barrel of oil is going up. And banks find their sterling assets are now depreciating.
Lots of people think all of us are losers because the UK economy is now in trouble.
Why is the FTSE loving this?
Because many companies in the FTSE 100 and FTSE 250 get their earnings abroad. The likes of HSBC, GlaxoSmithKline and Wolseley are all seeing nice boosts to their share prices. Even the mid-cap 250 index, which has a more diverse group of companies that better reflects the UK economy, is enjoying sterling’s pain, since it is populated by commodities companies. Interest rates are low so the dividend yield from equities is more tempting than yields from other markets.
Caution: this is one way of looking at the FTSE. Another is to measure FTSE companies in dollar terms, and when you do that you see that the FTSE is down over the course of the year. Compared to US companies and other peers, UK companies are underperforming in the long term.
Even so, the FTSE may be benefiting from the surprisingly good economic data since Brexit and the neutralisation, thus far, of fears about recession. There is also the prospect of a weaker pound firing M&A activity.
“While we expect Brexit fears to bite at some stage, the strength of the FTSE 100 is reflective of the fact that Brexit hasn’t had too much of an impact on the UK economy so far,” says Kathleen Brooks at City Index.
Could sterling fall lower still?
Most certainly. Let’s face it: the government doesn’t know how Brexit will turn out, the Bank of England doesn’t know, the market doesn’t know, companies, shareholders, the man in the street don’t know. Many things determine a currency’s rise and fall, but in the pound’s case Brexit is way ahead of other causes.
In crude terms, Brexit could be good or bad for the UK. Right now, Brexit is in the tray marked “Uncertain”. And since the market hates uncertainty, the chances are that traders’ instincts will lean towards selling the pound. Currencies are probably the best proxy for the market’s opinion of a country’s economy, and when the pound fell sharply in the days after Brexit, the market had effectively downgraded the UK. That much was expected by most economists.
What matters to governments and central banks is the size and pace of currency moves. And after a summer lull, when the economy seemed to be doing better than expected, forcing economists to update their sterling forecasts, the pound is again being heavily sold relatively quickly. A pound was worth nearly $1.30 at the start of October. Barely a week later, it is worth closer to $1.24. That’s quite a decline.
Currencies move in strange ways. There is never a smooth path up or down (or sideways). Here’s Richard Bibbey of HSBC: “We’ll likely see a short period of consolidation before a further period lower. However, if we remain at these levels for a period of time, the less likely it is to materialise.”
What does it mean for investors?
Sterling’s fall has already had its impact on equities, and it has also made a difference to the cost of borrowing since the Bank of England has begun resuming the purchase of bonds. The next few weeks will be tricky. Will equities run out of steam? Will yields in gilts rise? There were signs of both towards the end of this week, as the reality of Brexit hit that bit harder.
Much depends on how much further the pound falls. A more sustained sell-off may spook foreign investors in gilts, thereby driving yields higher. Curiously, the way the market works, that may end up halting the pound’s fall. It may also hurt equities, since low bond yields have been a factor in rising share prices by virtue of their inflationary effect on future cash flows of companies. No one said Brexit was going to be easy.
As a consumer, when will I start feeling the impact of this?
Your fuel tank is probably going to cost more to fill and your holidays abroad have already cost more, which means a staycation not too many miles from home is your best bet for next summer.
At some point, the high street will have to weigh up how to factor in the pound’s fall. Retailers’ import prices will rise. They will have hedged against currency risk, but those hedges will expire at some point. They can jack up prices for the consumer or swallow the impact of the import rise for fear of losing the customer.
The chances are that retailers will see their way through to the end of the year and protect their Christmas sales, and take a view at the start of 2017. Much depends on consumer confidence. This is steady for the moment, but never far away from reversing course, particularly if headlines about rising inflation spook shoppers. The headlines had already started on Friday.
What does it mean for the housing market?
House-hunters looking to buy in the UK with foreign currency — particularly the dollar or dollar-pegged currencies — have seen their purchasing power soar in recent months. In London, the effect has been accentuated by falling prices at the top end of the market.
LonRes, a data provider, said average values paid in US dollars per square foot in central London had dropped by 29 per cent between the peak in 2014 and August this year, “making prime central London, for those buying in US dollars, the most affordable it has been since 2012”.
Estate agents reported a surge in interest, if not completed deals, from foreign buyers. David Adams, managing director of John Taylor, a Mayfair-based estate agent, said there had been a 1,000 per cent rise in such inquiries in the month following Brexit compared to the previous month, and interest had been most acute at the ultra high end of the market for homes above £30m. “Many more people have been calling us to say that they think they should be looking for something because of currency,” he said.
However, he was struggling to find the supply of homes to satisfy this demand, since there was a corresponding fall in UK homeowners transacting. “They don’t think now is the right time to move,” he said.
Aaron Strutt, product manager at broker Trinity Finance, said worries among EU nationals living and working in the UK about the prospects of residency controls after Brexit were beginning to lift, and consequently groups such as French and Italian expats were returning to the market.
How could it affect my pension?
Many of the estimated 1.1m pensioners who have retired abroad will see a dramatic fall in the spending power of any UK state or private pension income.
A year ago, £100 would have secured $200 in Australia, one of the most popular retirement destinations for British expats. But this week, the same £100 of income would only return A$169, or 15 per cent less.
There were similar falls in spending power for the estimated 400,000 UK pensioners living in the eurozone who receive the UK state pension. “Currency risk is a major issue for expats,” said Mike Morrison, pension analyst with AJ Bell, the pension provider.
“It is possible to buy a forward contract for currency exchange, which can provide a level of certainty on the exchange rate but they are mainly used for large purchases such as house purchases.”
Mr Morrison says the simplest answer for expat pensioners is to use income from other sources if possible and leave the pension untouched until the pound recovers. “However, this may not be possible if the pension is the only source of income and it looks like the pound is going to remain weak for some time to come.”
What does the rest of the world think about the falling pound?
One school of thought suggested some countries were jealous of the UK. In a world of stubbornly low growth, a weaker currency was one way of making your economy competitive.
Except that if everybody did it, you would soon be embroiled in a self-defeating currency war, which is why a US-led initiative back in January led the world’s developed countries to agree not to target deliberately weaker currencies. Hence when Brexit induced sterling’s plunge, the UK looked as if it had accidentally stumbled on a unique way of getting itself a weaker currency.
This is all very well if you can manage the currency’s fall in a measured way. And that is not what this week’s drop feels like. Opportunists around the world will grab UK assets, which have suddenly become cheaper.
But will foreign investors see the UK in the same favourable light? If they start to pull out their money on a big scale, that poses problems for servicing the UK’s pretty large current account deficit. Bank of America Merrill Lynch says: “The risks are skewed to a weaker sterling next year amid policy uncertainty and constraints on current account deficit financing.” You have been warned.
How can I minimise the impact of sterling’s fall?
Play the currency markets and hedge against sterling’s fall, although it is costly, complicated and by no means foolproof. Alternatively, get on the right side of the pound’s weakness — invest in UK exporters, open a bed and breakfast in a popular tourist town or buy shares in a UK-listed energy company which reports its earnings in dollars.
The other option is to position yourself for the pound’s rise. This is based on believing either that a) sterling has hit the bottom; b) it will rebound on the back of the economy staying resilient; c) Brexit will turn out to be soft and even cuddly; d) a combination of all of these. There were a few economists who believed this a few weeks ago. You may need to wait a while for them to resurface.
Is there anything else that’s going to move the pound either way?
Currencies are two-way. A currency trade happens when one currency is bought and another sold. So when the pound is bought or sold against the dollar, more often than not there are influences on the US side that come into play.
Hence, the US election, the state of the economy and the prospect of rate rises across the Atlantic can all push the dollar higher against the pound. Similarly, eurozone developments will affect the pound’s level against the euro. US and European influences were coming back into play in recent weeks as fears about Brexit’s impact on the UK economy were kept at bay.
That all changed this week. UK politics is back at the wheel driving the pound and the quality of driving is erratic, to say the least.
Additional reporting by Josephine Cumbo and James Pickford
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