A weak pound

October 6th, 2022 | News | By Graham Wingar

Although it has recovered slightly following the additional rate tax cut reversal, the pound is still far below its longer-term average against the dollar. Last week it hit an all-time low of 1.04$ compared to 1.36$ a year ago.

As the majority of long-term investment growth is driven by equity returns, we look at the effect of the weaker pound on equities.

Following the chancellor’s radical package of tax changes, the Bank of England have a difficult balancing act. The Bank of England’s primary role is to set interest rates to control inflation. With the new proposed tax changes, the BoE’s monetary policy makers will need to consider whether they may help or hinder the current high inflation. The governments energy policy is expected to bring down inflation in the short term by directly combating household bills which is a significant contributor to the current high inflation. The concern for the BoE however is that this, along with the proposed tax cuts may fuel consumer spending and subsequently inflation. This would also be amplified by higher prices of imported goods caused by the weaker pound.

Given this economic concern, how can we still be positive on the equity Market?

The UK equity market is not the same thing as the UK economy. UK equities on aggregate derive around 75% of their revenues from outside the UK. Having a weaker pound means that these overseas earnings are increased in sterling terms, thus supporting their overall revenues and valuations. Of course, any valuations on overseas companies will have improved in pound terms following the weakening of the pound. We do not expect anyone to be able to predict currency markets, instead it is important to have an investment portfolio that is not heavily exposed to movements in currency in one direction or the other. It is clear there is still much to do for the UK government to control its current economic situation over the longer term. Having a balanced investment exposure during this time, although volatile will mean the investment is well positioned to provide returns when markets settle without over exposure to currency rates.