In November 2018, the Bank of England issued a stark warning over the economic effects of a no-deal Brexit. Governor Mark Carney said it could send the pound into a double-digit plunge.
In fact, since the referendum on leaving the EU in June 2016, the pound has dropped sharply against other major international currencies.
Today I want to discuss how the choppiness in the exchange rate may affect economic life in UK as well as the value of British companies in your portfolio.
How the pound has fared
The pound’s dramatic fall started just as the outcome of the referendum became clear. Investors regarded it as an unprecedented development for which there was no blueprint.
For example, the value of sterling relative to the dollar fell from about $1.47 to $1.22 just five months after the referendum. Currently, it is hovering around 1.25.
The pound also fell sharply against other currencies, especially the euro. On 22 June 2016, the pound was about 1.30 to the euro. In November 2016, it was about 1.16. Currently, it trades around 1.12.
Most of our readers are well aware of the fact that financial markets despise uncertainty and the developments surrounding Brexit have been less than certain.
In the early weeks of the Brexit result, traders’ jitters send the value of the pound to levels not seen since mid-1980s. And now over the past few days, sterling has rallied to a recent high as no-deal Brexit fears have begun to recede.
Will it all go back to normal at some point? Maybe not. Many commentators feel that the task of unwinding the deep trade, political, and social links established over 40 years will likely have long-lasting effects on the UK economy and the pound.
Ups and downs
But a weak pound is not all bad. In simple terms, a devaluation of the pound would make British goods cheaper to buy, potentially boosting the amount of UK exports overall.
That said, a weaker pound makes imported raw materials more expensive. And the increased costs eventually get passed down to the consumer.
But most of the FTSE 100 companies are multinational conglomerates and up to three-quarters of their revenue comes from overseas.
Therefore, when the pound falls, especially significantly, their sterling-denominated earnings rise considerably. The dollars and euros they are earnings outside the UK become worth more pounds, leading to an increase in profitability.
The effects of exchange rate movements tend to be less clear-cut for the companies in the FTSE 250 index as they have usually have a more domestic focus. So they are more directly affected by the short-term developments in the economy and consumer sentiment.
What about a general election?
Perhaps one of the most important unknowns in the coming months is if we will have a general election. Although it would be impossible to know what the result of the election would be, we can assume that initially there would be uncertainty for companies and consumers alike. And at least in the short run, that would not bode well for the pound.
In short, economic and political developments affect the exchange rate, which in turn affects companies and their share prices. However, it is almost impossible to know the exact effect of any one event on a given company or on FTSE 100 or FTSE 250 shares.
The answer? Keep calm and keep investing regularly in good companies.
