Don't underestimate sterling's weakness

Don't underestimate sterling's weakness

The sterling weakness we saw last year was clearly associated with Brexit, and the vote to leave led to a significant slide with a 16 per cent fall against the dollar between the referendum and the end of the year. However, it is important to note it has been falling significantly since at least mid-2015.

This is something we expected at the start of last year, not the outcome of the vote, but the impact on sterling of the upcoming referendum. As a result we were looking to diversify and identify funds with denominations in other currencies where possible.

After the referendum sterling fell dramatically relative to a number of developed market currencies, notably the euro, yen and the US dollar. After the initial shock of the result the equity markets sold down dramatically but investors quickly, and rightly, deducted that the fall in currency would be beneficial to many UK companies. This is particularly true for the FTSE 100 as the majority of these businesses now generate a sizeable amount of their revenues from operations overseas. Thus the fall in the currency would increase any assets they repatriate from abroad and ultimately boost profits.

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In the 24 hours after the referendum sterling fell by up to 10 per cent. And although the FTSE 100 also fell initially it quickly recovered and went up around 8 per cent in the following week. It is quite simple when you look at it. However, this was not something investors had expected or planned for prior to the referendum.

A lot of key market participants were extremely negative on the outcome for the UK should a Brexit vote come to pass. However, they could not have been more wrong. As a UK investor you have a portfolio of investments in multiple regions. Much of this exposure tends to be unhedged so the dramatic fall in currency proved beneficial not only for the UK element of your portfolio but also your US, European and Asian equity exposure.

This flew in the face of a range of experts from the IMF to the Bank of England who went as far as cutting rates in response. Growth has not slowed, and inflation has only ticked up. There is always a tendency to overestimate the impact on markets of potentially negative events. In reality this has not come to pass.

But when will this unravel? Will the pound start to strengthen and the FTSE sell off? At this time it seems unlikely. Prime Minister Theresa May is committed to a hard Brexit, which has now been backed by parliament. The two-year time frame to leave the EU is purely a guide and it is expected to take much longer given the complicated nature of the separation. Unfortunately this leaves sterling in a period of limbo, having been a darling of the investment world prior to the Scottish referendum. It is the political risk that has eroded overseas commitment to the UK market. 

As we saw during 2016 overseas investors positively fled from the UK. This was based on expectation. Now we have sufficient hard data on the performance of the UK economy, they were clearly wrong in their assumptions.