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Sterling doesn’t take a holiday

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Summary

A falling or rising pound presents opportunities as well as risks to investors and can benefit portfolios if handled properly.

2 min read

Whether you’re a saver, investor or consumer, the value of the pound affects you every day. 

We all think about what the pound’s worth when we change our money for a holiday in the sun. But with the summer season coming to an end, a weaker pound still affects you in more ways than you may realise.

Sterling’s value relative to other currencies fell in the immediate aftermath of the European Union (EU) referendum in 2016 and has had its share of ups and downs since.

Coutts Head of Investment Strategy Sven Balzer says, “While sterling’s weakness against the dollar and euro has been expensive for people travelling – and spending – abroad, it has actually been good for the earnings of large international firms like those of the FTSE 100 that we hold in our portfolios.”

He adds, “Sterling is likely to continue swinging around over the coming months depending on the latest Brexit headlines. But our view is that over the long term it remains undervalued.”

 

The real price of sterling’s slide

A weak sterling does more than make holidays expensive; it can raise prices across the board.

When sterling is low, UK companies pay more for the equipment, components or ingredients they buy overseas. Those extra costs are usually passed on to the customer in the form of higher prices.

Also, the price of oil is a key driver of inflation and, as it is priced in US dollars, the pound’s weakness has pushed up prices. That has had a knock-on effect for UK consumers as oil affects the price of anything that requires transport or machinery, as well as the fuel in your car.

As the latest Coutts Luxury Price Index shows, inflation on high-end goods and services is double that of mainstream products. One of the reasons for this is that many of the luxuries we track are imported, getting a double whammy from a more expensive base currency and higher fuel costs.

“While sterling’s weakness against the dollar and euro has been expensive for people travelling abroad, it has actually been good for the earnings of large international firms like those of the FTSE 100 that we hold in our portfolios.”
Sven Balzer, Coutts Head of Investment Strategy

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Weaker pound, stronger profits

However, a weak pound can be good news for investors. Many of our portfolios are well diversified geographically, and a weaker pound means that assets denominated in US dollars or euros, for example, are worth more for sterling-based investors.

Additionally, a weaker sterling is often positive for UK equities. Typically, if the currency is weak, it lets UK equities – especially shares in multi-national companies – rise as foreign earnings benefit.

The FTSE 100 derives about two-thirds of its revenue from overseas so it does particularly well from the weak pound. We saw this in 2016 when sterling fell sharply after the EU referendum while the FTSE 100 rose by over 10%.

We increased our exposure to the FTSE 100 in February following a fall in price and benefitted from the subsequent rebound, which was driven in part by continued sterling weakness. While it’s worth remembering that past performance is not a guide to future performance, this has been positive for us so far.

 

The sterling story

Sterling hit an 11-month low against the dollar at $1.28 last month, remaining weak despite the Bank of England raising interest rates which usually strengthens a currency.

This is mostly a result of the uncertain Brexit talks, but also the general strength of the US dollar and economy compared to more mixed data in the UK. The country’s manufacturing and construction growth fell in August while the services sector continued to expand, according to the latest IHS Markit Purchasing Managers’ Indices.

In our view, while the UK economy faces its fair share of challenges, it remains reasonably sound, supported by:

  • the global economy
  • strong domestic employment
  • service sector growth

Past performance should not be taken as a guide to future performance. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

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