The pound has risen sharply in recent days, but how much higher can sterling go? What are the implications for investors?
Sterling is up, how much higher can it go?
The odds of a no deal Brexit are diminishing. It seems that the only way that the UK will crash out of the EU without a deal is if two things happen:
- Firstly, the EU itself refuses to grant an extension
- And in the event of that, UK parliament still refuses to ratify Boris Johnson’s proposal.
The above seems unlikely. It seems that we will end up with what in some respects is something quite democratic. Neither hardcore Remainers nor hardcore Brexiteers like the deal the Prime Minister has proposed, but perhaps that is how it should be: in a country as divided as the UK is right now, a deal that seems unpalatable to both extremes might be the only solution.
The pound has risen strongly on recent developments. It has risen from around $1.20 back in August to $1.29 as I write and from €1.06 to €1.16 over a similar time period.
In fact, against the euro, it is close to a year high.
It’s still a lot lower than the levels it was trading at before the Brexit vote. On the eve of the last referendum, it was trading at around €1.27, for example. Indeed, in 2015, the pound peaked at €1.44 and $1.58. That was of course back during the period when the UK was the fastest growing economy in the G7, and one of the fastest growing across the entire EU.
What does this mean for investors?
As a general rule, and from the point of view of UK investors, companies which are listed in the UK, but do most of their trading in overseas territories, benefit from a fall in sterling, as their profits, when measured in sterling, increase.
And for companies that mainly trade domestically, or are big importers, or both, a falling pound is negative.
A high proportion of FTSE 100 companies do much of their trade overseas. This has been reflected in the indexes’ performance.
The FTSE 100 is up roughly 18 per cent since the EU referendum. Then again, the FTSE 250 is up by even more.
This all begs the question, what next?
According to Capital Economics, if the chances of a no deal fall to zero per cent, then sterling could rise to $1.35.
I assume the pound would be expected to rise by a similar amount against the euro.
Of course, there are a lot of uncertainties out there.
While I would say is that the odds of a no deal are now quite slim, the possibility of another general election, creating a parliament in which both the LibDems and Brexit party hold a substantial number of seats, is not remote. In such an event, a second referendum may indeed happen.
I have been in favour of a second Referendum for at least a year. If this had already occurred, it would have unlocked the Westminster deadlock. I reckon the Referendum should consist of a three way vote: no deal, deal and Remain. The electorate should be asked to give their first and second choice. In the event that no single argument gets more than 50 per cent, the second choice cast by those who voted for the least popular option would be taken into account.
Such an outcome would be the most democratic solution and be the optimal way to reunite the country. I believe that in the event of such a vote, if the Remainers lose, the vast majority would accept the outcome of the vote.
If the above were to happen, and let’s be clear, it is more likely that Boris Johnson’s deal will go through in the next few weeks, but if this second referendum went ahead then that would mean as follows:
- Continued uncertainty for business. This would be reflected in the value of the pound. For businesses that have built-up stock in order to prepare for a worst case no deal, the strain on cash flow would be considerable.
- In the event that a second referendum confirms Boris Johnson’s deal, then the pound should react the way I described above.
- In the event that a second referendum vote chooses no deal, then sterling should fall much further.
- In the event that a second referendum overturns the result of the first, and the UK cancels Brexit, sterling should rise much higher than suggested above.
The UK has the largest current account deficit in the developed world. This is a serious problem in the making, and whatever happens with its future relationship with the EU, the current account deficit must be reduced. But, I suspect, that in the event of a cancellation of Brexit, money will flow into the UK, the pound will surge and the current account deficit will widen.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees