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What does the falling pound mean?

Tom Stevenson

Tom Stevenson - Investment Director

Some people like to argue that a falling pound is good news for the British economy. They say it makes our exports more competitive and increases the value of companies’ overseas earnings.

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In the short term this can create a kind of Pavlovian response in the stock market whereby the FTSE 100 rises most on those days when the value of the pound falls most against our major trading partners’ currencies.

This has been the case during July, a month in which the pound has fallen by more than 4% against the dollar. Since May, sterling has depreciated by 7% against both the dollar and the euro. During that period, the headline value of Britain’s biggest shares has risen by roughly the same amount.

Seeing the UK’s benchmark index rise might give us a warm feeling, but it is a bit of an illusion. The reality is that a falling pound makes all of us poorer.

The reason weak sterling is bad for us is that it makes everything we import from overseas more expensive. And because Britain imports more than it exports that means the net effect of a falling pound is higher prices.

This is most obvious at this time of year when we are likely to find ourselves wincing at the foreign exchange counters. If you are foolish enough to change your money at the airport you will have the unpleasant experience at the moment of receiving less than one Euro for every pound you hand over.

At that exchange rate, the prices you will have to pay in Paris or the Algarve will be eye-wateringly expensive.

Another reason weak sterling is bad for the country is that most of our apparently-competitive exports are put together using components or raw materials that we have just imported at a higher cost. So the benefits of cheaper sterling to an exporter are pretty much illusory.

Soon enough any market share gains evaporate and the problems which caused the pound to fall in the first place remain. We should not forget that sterling is weakening not as a deliberate policy to promote our businesses’ competitiveness but as a vote of no confidence by overseas investors in the seriousness of our politics and the health of our economy.

It is no coincidence that the pound has taken another leg lower in the past week or so as the prospect of an economically-damaging no-deal Brexit has increased.

It is also the case that the positive impact of a weaker currency seems to have diminished in recent years. The slide in sterling after the 2008 financial crisis actually made little difference to Britain’s trade balance.

The fall in the pound since the EU referendum simply encouraged exporters to put their prices up rather than increase their market share.

A third reason we should not welcome a weaker pound is the bind it places the Bank of England in. The monetary policy committee, which meets this week, may decide it wishes to cut interest rates to offset the uncertainty of Brexit, but its hands may well be tied by rising inflation on the back of a falling pound.

The Bank of England estimates that a 5% depreciation in sterling adds 0.9% to consumer prices. The increases are most obvious in food and energy bills, which means that the hardest hit by a falling pound are the poorest, most vulnerable people for whom these costs represent a bigger slice of their overall budgets.

There is one silver lining to the cloud of a weaker pound. For investors with a well-diversified portfolio, the value of overseas investments is enhanced by sterling’s fall. This is just another reason for UK-based investors to avoid the home bias that characterises so many portfolios.

It is tempting to invest in what you know but if the pound is sliding as it is today, you will pay a high price for the security of familiarity.

The Select 50 list of our favourite funds spans five regions - the UK, US, Europe, Japan and Asia Pacific ex Japan. In addition, the global category includes funds with heavy weightings to non-UK businesses. The alternatives and bonds categories also include funds that invest on a global basis too.

No-one should pretend that a weaker pound is good news. But a well-spread portfolio of investments can help offset the worst impact.

Important information The value of investments and the income from them can go down as well as up so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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