Why is the pound rising? - FIDELITY
NOVEMBER 24, 2022
JUST when you thought it couldn’t get any worse, it didn’t. A deeply adverse market response to the Kwarteng Budget of late September marked the start of a recovery in the value of the pound versus the dollar from around 1.07 to almost 1.19 today1.
That’s quite a move and one that should soon start to exert some downward pressure on inflation. Part of the reason for the UK’s high inflation rate – which is now significantly above America’s – has been a depressed exchange rate, which has made imported goods more expensive.
Evidently, the pound’s recovery has been part-driven by growing international confidence that the UK is getting its spending and borrowing plans in order after the scare of September’s Budget.
However, a fall in the dollar has also played its part. Markets have started to price in the possibility US interest rates will peak sooner and at a lower level than was widely thought a month ago, as well as a future switch in focus from controlling inflation to providing support for a slowing US economy.
From an investing standpoint, the effects of a strong pound can be far reaching provided the strength is sustained. Perhaps the companies set to benefit the most are those that have experienced difficulty passing on their rising input costs to British customers.
B&M European Value Retail and Next are prime examples of businesses that buy in foreign currencies but sell in pounds and both have seen their shares decline for much of the year so far2.
The opposite applies to British companies that sell their products mostly overseas. Businesses likely to be negatively affected by a strengthening pound include BAT, Diageo and Unilever.
Another consequence of sterling strength is that foreign assets become cheaper to buy. Given the pound’s precipitous drop from over 1.40 against the dollar in the summer of 2021, it’s been quite a time since investors have received any help in that direction2.
Up until recently, investors with holdings overseas have been benefitting from a weak pound, because it will have boosted the value of their assets and, in some cases, dividends in sterling terms. If the pound continues to recover, that boost will turn into a drag.
On the face of it, a strong pound would seem to favour UK assets over foreign ones. However, concentration risk is not advisable, especially in today’s uncertain and volatile economic climate. The plain fact of the matter is that currency exchange rates are invariably tricky to forecast, meaning that a broad currency spread is the best option for most investors.
For those investors encouraged to increase their exposures to the UK there is, however, reason for optimism. Having acquired something of a backwater status among global investors ever since the Brexit referendum, the UK stock market has become inexpensively valued both compared to its own history and its global peers.
For an economy more than two thirds driven by domestic consumer spending, a strengthening pound could be just what the doctor ordered.