With an election out of the way, what is the potential change for Sterling and how will that affect your finances?
Much razzamatazz in the press greeted UK readers after the Conservative victory in the election. Headlines of ‘Sterling skyrockets against the Euro’ were pretty mainstream.
Currencies, and in particular Sterling, map political uncertainty and are often a bellwether of sentiment. 1967,1976,1992,2008 and 2016 being very obvious examples.
Beyond that razzamatazz is the fact the ‘skyrocket’ has simply taken Sterling back close to its Euro/Sterling rate the day after the UK referendum in 2016.
So it was still below the post Brexit vote let alone the pre Brexit vote. Nothing has changed.
My surprise was that it didn’t surge more, which is a sign the market sees/saw further concerns.
Sterling falls or increases have significant impacts on your financial wellbeing:
As the UK is a net importer, any weakness in Sterling increases the cost of imports which are passed straight into inflation. The Bank of England will then move to ease that pressure with increasing interest rates, and so, those with a mortgage will see higher mortgage rates, as well as a higher cost of living because of the inflation. It’s another ninja austerity;
Any increase in the value of Sterling lowers the cost of imports and eases inflationary pressures/ chances of interest rate increases;
Any investments/pensions you have with exposure to overseas global funds receive a boost when there is a Sterling weakness, as the earnings are translated from that stronger foreign Currency back into Sterling at a lower exchange rate. That is indeed why the FTSE100 performed so well after Brexit as c70% of the revenues were from a Currency other than Sterling;
Similarly, any thoughts that Sterling was to appreciate would mean that the much unloved UK domestic stocks become doubly attractive. An overseas investor such as larger pension funds/investment institutions, would see a positive turn in Sterling as the time to invest, as they would benefit from the improving Sterling exchange rate, added to the upward surge in the stock market.
So what’s in store for Sterling?
There is a simple method called the ‘rule of four’ that is used to assess danger in the Economy of OECD countries. Measuring its current account, its budget deficits and inflation, if an Economy breaches 4% of its Gross Domestic Product (GDP – its Economy) or more, in any one of these, it’s problematic. If it’s two, it’s into danger.
The UK is currently running two deficits: A balance of payments deficit (basically the difference between imports and exports) of 5.5% of the country’s GDP, and the government deficit (difference between taxes and spending) which, although already under upward pressure, is expected to head to 3% if the current spending plans announced in the election are not funded by tax increases.
Let’s now understand how important a trade agreement is with the EU. We know Brexit is set to reduce the GDP of the UK by over 3%. The unknown, outside of that, can put further downward pressure on the currency.
Therefore, anything other than a really good deal will weigh heavy indeed on Sterling, and could well lead to a crisis.
The counter to that is that Sterling has traded at around 20% below Fulcrum’s exchange rate valuation models since the 2016 vote. So, it may be that Sterling already has that undervaluation attached.
The important unanswered questions have, and will weigh until the Brexit deal has clarity. That will be the point at which international investors will vote with their confidence. The elimination of Brexit uncertainty and indeed a bad deal still remains the key balancing decision.
Notwithstanding that, clever investors in Sterling bought the ‘rumour’ (market chat) and sold on the ‘fact’ (the real numbers) which meant Sterling dropped off after the election taking profits from the gains that were made since a ‘no deal’ became much less likely.
A government with a working majority is undoubtedly in a far better position to spare the country from the chaos of leaving the EU without an agreement.
About the author
Peter McGahan is Chief Executive of Independent Financial Adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.
If you have a financial question please call 01872 222422 or visit WWFP.net.Last modified: June 10, 2021