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The pound is holding its own again today, remaining at its highest level against the dollar in almost three years, with the prospect of an ‘irreversible’ end to lockdown in the UK, appearing to be buoying up the markets.
Sterling topped $1.39 yesterday, taking it to a new 34-month high against the dollar, while also hitting a nine-month high against the euro at €1.147. Meanwhile the UK's main share index, the FTSE 100, also climbed on Monday, rising by 2.6% and is continuing its upward trajectory today.
A strong vaccine-led recovery is the most likely reason behind all this positivity. The UK economy is heavily reliant on the service sector. Anything then that frees that up is a positive.
The significant shift in sentiment towards the pound also has a lot to do with the Bank of England, which at the start of this month, effectively signalled negative interest rates would not be introduced in the UK in 2021. Much of the optimism surrounding the pound, stems from the success of rolling out a coronavirus vaccine at a quicker pace than other major regions such as the EU.
The sense that the UK economy is on the cusp of a long-awaited release and rebound would also explain the uptick in the stock market. But the relationship between currency valuations and the stock market is notoriously complex.
Having said that, one thing that we do know for certain is that financial markets hate uncertainty. We have had a year of uncertainty over the pandemic, but we have also had four years of uncertainty over Brexit.
The end of Brexit uncertainty had an immediately supportive effect on the pound, with a relief rally following the announcement of a trade deal agreement at Christmas.
Following the referendum result in June 2016, the pound’s dramatic fall started. It went from around $1.47 against the dollar to $1.22 in just five months. Then at the end of 2020 as hopes of a deal finally emerged sterling’s exuberance was plain for all to see, with hopes of a breakthrough in Brexit trade talks pushing sterling to its strongest level since May 2018. On the last day of 2020 it was at its highest level of the year at $1.36 against the dollar.
Typically, of course, a strong pound is not all good news. As the bulk of the FTSE 100 index is made up of companies that are multinational conglomerates who get up to three-quarters of their revenue from overseas, a weak pound is instead seen as more positive news; making British goods cheaper to buy for overseas customers, causing these companies’ sterling-denominated earnings to rise and potentially boosting UK exports and profits.
This time it is different though. And a little of this could also come down to so-called ‘magical thinking’ or even irrational exuberance. A lot of it probably comes down to good old ‘market sentiment. But then markets are moved by sentiment - a useful catch-all that I used more than once, back in the day when I wrote The Daily Telegraph’s daily stock market report, to explain away welcome, but otherwise irrational, movements in the markets.
Of course, we are not out of the woods yet, as the Prime Minister is keen to caution, but all the signs are that things are moving in the right direction. The figures released on Friday revealed the UK had avoided a double-dip recession, but a disappointing performance in the services sector - which has been so badly hit by not one but three national lockdowns and close to a year of turmoil - could still raise concerns that the Bank of England will be forced into monetary policy decisions that could see rates slide into negative territory. The release of inflation and retail sales data for January, due out later this week, will give us more information on the spectre of that happening.
But, for now, with the roll-out of the vaccine programme expanding and with it hopes of the bounce-back in the economy all the more likely, the green shoots of optimism are clearly taking root.
The unloved UK could very well be back in business and the task for investors now is to find and invest in these over-looked stocks while they are still looking relatively cheap.
Five year performance
|(%) As at 15 Feb||2016-2017||2017-2018||2018-2019||2019-2020||2020-2021|
Past performance is not a reliable indicator of future returns
Source: FE, total returns in GBP terms as at 15.2.21
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