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.

A busy week for central banks is pointing to further recovery in the value of the pound versus the dollar. When we are finally able to consider a trip across the Atlantic again, it should be just a bit more affordable.

There are two sides to this foreign exchange calculation, of course. Pound strength and dollar weakness. On both fronts we had useful hints this week.

Last night’s Federal Reserve meeting was unambiguous. Interest rates were left at close to zero and the current rate of asset purchases - $120bn a month - was confirmed. This was despite a slight increase in future growth and inflation expectations compared to the last assessment in September.

Perhaps more importantly only one new member of the open markets committee sees a rate hike occurring before 2023. Let’s not forget that this will be 15 years after the financial crisis. Most importantly of all, Jay Powell, the Fed chairman, said that any future reduction in stimulus will require ‘substantial’ progress towards maximum employment and the Fed’s inflation goals.

So, even by the standards of the accommodative Fed, this was a dovish announcement. Monetary policy will continue to boost the economy for the foreseeable future and may even be intensified if necessary. This suggests continuing weakness for the dollar.

On the other side of the balance, the pound has also received a boost this week on two fronts. First, today’s decision to leave interest rates at 0.1% suggests the prospect of negative interest rates in the UK is reducing.

Second, it is clear that the political will is strong on both sides of the Channel to secure a trade deal before Christmas. The decks have been cleared for a fast-track parliamentary approval next week, assuming that an agreement is not scuppered by President Macron’s support of French fisherman, the final apparently most challenging hurdle in this sorry saga.

Rising hopes for a Brexit deal have pushed the pound to its highest level against the flagging dollar since May 2018. If a deal is struck this week then the pound should push even further ahead from the current $1.35, perhaps towards $1.38.

What does this mean for investors? All other things being equal, it is probably better for smaller, more domestically focused companies than the big international stocks in the FTSE 100. The large exporters and overseas earners in the blue-chip index prefer a weaker pound because it makes them more competitive abroad and raises the value of their foreign profits on translation back into sterling.

Investors should also consider how sustainable a stronger pound might be as we move into 2021. A Brexit deal would be good for sentiment in the short run, but no-one is pretending that it will be plain sailing ahead for the UK economy, cast adrift from its biggest trading partner.

For investors looking at where to allocate their portfolios in the year ahead, the currency is just one factor though. The UK stock market has underperformed rivals, notably the US, by a wide margin in recent years. And that has left it cheap and unloved.

An improving economy on the back of a steady roll-out of vaccinations in 2021 will make it easier for companies to justify restarting their dividends. And that will underpin one of the greatest attractions of the UK versus its peers.

Recovery in the UK market is one of the key themes of my fund picks for the next 12 months. My uncertainty about whether the growth or the value style will prevail in the year ahead means I’m proposing two UK funds this time: the growth-focused Fidelity UK Select Fund; and the value-biased Fidelity Special Situations Fund.

Read more about all five of my picks

Important information: 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. Fidelity UK Select Fund invest in a relatively small number of companies and so may carry more risk than funds that are more diversified. Fidelity Special Situations Fund and Fidelity UK Select Fund use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Both funds use currency hedging. Currency hedging is used to substantially reduce the risk of losses from unfavourable exchange rate movements on holdings in currencies that differ from the dealing currency. Hedging also has the effect of limiting the potential for currency gains to be made. Please note that Tom’s picks are not a personal recommendation for you. If you’re unsure about the suitability of these funds for your personal circumstances, you should speak to an authorised financial adviser.

Topics covered:

Active investing; Funds; UK; Volatility

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