For UK businesses buying from or selling to the rest of the world, the Brexit vote in June 2016 ushered in a period of sterling currency volatility. Now Brexit has actually happened, how can we expect sterling to perform against other major currencies in the short and medium term?
Clearly, a starting point has to be to recognise that predicting future outcomes for currencies is pure guesswork. However, there are certain themes that should be considered which help us understand what the different directions of travel might be.
It is helpful to begin by setting out some key drivers of currency strength and weakness.
- Confidence in the underlying economy: sterling fell heavily after the Brexit vote partly because international investors sold sterling in the expectation that the British economy would suffer from leaving the Eurozone.
- Desire to hold assets denominated in the currency: its no coincidence that sterling hit a post financial crash highpoint in 2014 when London residential property became sought after by investors all over the world.
- Relative weakness of the US dollar: as the world’s ‘reserve’ currency, movements in the US dollar have a disproportionate impact on other currencies. Whenever there is a global stockmarket crash, the US dollar will strengthen because the global safe haven asset is short term US government loans: so everyone sells other currencies to buy dollars. The corollary is that when stockmarkets are booming and risk appetite is high, investors will reverse the trade and sell their US government loans to buy assets in riskier parts of the world that offer the potential of a high return.
Sterling is at close to its highest level since the Brexit vote, at near to $1.4 to £1, having recovered from a low point of around $1.2 to £1 only a year ago when the COVID inspired stock market crash happened.
The key drivers of the strengthening of sterling over recent months have been:
- Increase in global risk appetite which has encouraged investors to sell $US dollars and buy other currencies, including sterling.
- Increasing confidence in the UK economy as a consequence of the UK vaccination programme.
- An expectation that the British economy will not suffer as badly from Brexit as was once imagined.
So, if we are to look ahead at what the short to medium term picture for sterling might be, we have to consider what, of the above 3 points, might change.
- A reversal of global risk appetite looks unlikely for now in the light of the huge stimulus delivered by the US and other governments to tackle the COVID pandemic: there is a lot of money looking for a home and this will likely continue to drive up asset prices in the short term.
- The ‘successful vaccination’ boost that sterling has benefited from as a consequence of the British vaccine roll out being better than other major developed world countries may already be starting to peter out as other countries start to match the British effort.
- The final, and potentially most sensitive point, is the near term impact of Brexit on the UK economy: import /export data takes time to come through but there is increasing evidence that imports and exports have been hit heavily by Brexit trade red tape. If this picture continues to worsen, and the government’s optimism that red tape friction will be something that importers and exporters can overcome proves to be unfounded, then we could see confidence in sterling start to slide.
Taking these points together, it seems reasonable to conclude that once the vaccination boost dissipates, the near term outlook for sterling will be predominantly shaped by how robust post Brexit UK economic output is. In addition, if UK assets come back into favour with foreign investors, that could help support sterling but any upturn in interest in UK assets is more likely to happen if foreign investors see a strong post Brexit British economy so one can be expected to beget the other, or vice versa.
This article is issued by Portland Financial Management Limited which is regulated by the Financial Conduct Authority. Nothing in this document should be deemed to constitute the provision of financial, investment or other professional advice in any way. Past performance is not a guide to future performance. The value of an investment and the income from it may go down as well as up and investors may not get back the amount originally invested. This document may include forward-looking statements that are based upon current opinions, expectations and projections. We undertake no obligation to update or revise any forward-looking statements. Actual results could differ materially from those anticipated in the forward-looking statements.