If sterling is like an emerging market currency what should investors do?

Is sterling really like an emerging market currency and if so, what does that mean for investors?

Article updated: 7 July 2020 8:00am Author: Michael Baxter

A report from the Bank of America has said that sterling is like an emerging market currency.

The FT quoted Kamal Sharma, a currency analyst at BofA who said that the swings in the value of sterling make it more like the Mexican peso than a currency pertaining to an advanced economy. 

Apparently, the spread between the rates that investors are willing to buy and sell sterling is much greater than for other advanced market currencies.

Karmal Sharma said: “We believe sterling is in the process of evolving into a currency that resembles the underlying reality of the British economy: small and shrinking with a growing dual deficit problem similar to more liquid [emerging market] currencies.”

So let’s look at some hard numbers.

The falling pound

In early June 2016, a week or so before the EU Referendum, there were around 1.40 dollars to the pound and 1.30 euros. Right now there are 1.25 dollars and 1.11 euros.

Well, I guess we all know that sterling has taken a hammering post EU Referendum and we all have a pretty good idea why.

But what is perhaps a little surprising is the deviation between the pound, the euro and dollar since the Covid crisis.

Back in February there were 1.20 euros to the pound, and a little more than 1.30 dollars.

Of course Covid has hit the UK economy, but it has hit all economies, yet the markets seem to be telling us that they expect a bigger negative impact on the UK than US and Eurozone.

Brexit

Clearly, Brexit is an issue. The 12-month transition period is now half way through without a hint of a deal.

No doubt some fudged deal will be agreed just in time, but I am afraid that the UK is not impressing the rest of the EU at the moment.

Rarely has there been an occasion in my lifetime that has so clearly called for international cooperation. While the US has deliberately shunned this need, the UK has not been much better, more like a bystander, while the grown ups get on with the work.

What next for the pound?

The UK had been suffering from massive balance of trade deficits for years. Such deficits would have caused a run on an emerging market currency.

But the UK is not an emerging market; it is a member of the G7, the UK government is one of the few governments in the world that can borrow in its own currency. This means it has the option at the last resort of being able to pay back debt by printing money. That is why investors are so willing to lend to the UK government that yields on some UK bonds are now negative.

I suspect that once things settle down and go back to semi-normal, the UK’s trade deficit will remain enormous.

If sterling’s status changes, as the BofA suggests, then the likely future path of the pound is down.

Investing in an era of the cheap pound

A falling pound can create opportunities for investors.

For one, there is the opportunity to invest in overseas companies.

Personally, I think that Eurozone investing is quite appealing right now. Equities in the region look cheap relative to US companies, while the region had tackled Covid much more successfully.

The exception to the above arguments is US techs, which I think will continue to excel.

However, it is possible to gain from a weak pound by investing in UK listed companies, if you focus on companies that do most of their trading abroad.


These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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