Almost 18 months after the Brexit vote the pound has yet to get close to its previous strength. Investment analyst and former MoneyWeek deputy editor, Ed Bowsher, examines Sterling’s decline and fall and what it means for the pounds people have saved up…
On the day of the Brexit referendum, the market thought voters were set to vote ‘remain’, and the pound ended the day at $1.49. Once the result was out, sterling plunged 8% against the US dollar to $1.36 – the biggest one-day fall for sterling on record.
The downward trend continued through to January 2017, when the pound went below $1.20. We’ve also seen sizeable falls against all the other major currencies. Admittedly, the pound has retraced some of those losses, but at $1.32, it’s still a long way below its pre-Brexit levels. Here are two tables: the performance of the pound up to the end of 2016, and up to October 12, 2017.
Performance of £ against leading currencies June 23, 2016 to December 30, 2016
|Currency||June 23 2016
|Dec 30 2016
|£/South Africa rand||21.45||16.87||21.4%|
Performance of £ against leading currencies June 23,2016 to October 12, 2017
|Currency||June 23 2016
|Oct 12 2017
|£ South Africa rand||21.45||17.74||17.3%|
And in spite of that partial retracement – at least against the US dollar – I still think that the medium-term trend for sterling will almost certainly be down. I also think that applies for the long-term too. Now, you might imagine that my forecasts are predicated on Brexit proving to be a mistake, but I actually suspect that the pound won’t do well regardless of whether Brexit proves to be an economic failure or not.
Why did the pound fall?
Before we go any further, let’s just recap on why the pound fell last June. On June 24th, I think the fall partly reflected surprise and a big increase in uncertainty about the future of the UK economy. There were also concerns that British exports would fall once we left the EU, and normally a bigger trade deficit means a weaker currency. (Foreigners buying UK goods or services use Sterling and if foreign consumers buy less from us, there’s less demand for the pound and hence a lower exchange rate.)
As talk increased of a ‘hard Brexit’ or even a ‘no-deal Brexit’, the pound fell further before starting to turn around in January.
In 2016, the fall against the dollar was bigger than against the euro because the eurozone had problems of its own. Markets were worried about the Italian referendum and the French elections. But the euro has been stronger in 2017 once voters made the ‘right’ decision in those two polls – they were correct decisions according to the market anyway.
So where next for the pound?
Let’s park Brexit for now and look at another crucial issue – quantitative easing. We’ve had very lax monetary policy since 2009 with ultra-low interest rates and a huge amount of money-printing thanks to quantitative easing (QE). All other things being equal, you’d expect such a policy to push a currency down. After all, the supply of that currency has been increased and an ultra-low interest rate means that global ‘hot money’ may look elsewhere for a better return.
Broadly speaking, the US and UK have followed a similar monetary policy in recent years, so the pound/dollar exchange rate may not have been affected much by QE. Both countries are beginning to tighten monetary policy a little, but I suspect the US will do so more quickly. That extra pace across the Atlantic probably means the pound will fall further against the dollar over the next couple of years.
The story in the eurozone has been a bit different: QE started later there and the winding down process will probably take longer. That means Sterling may gain a little against the euro, or at least fall less against the euro than the dollar in the next two or three years.
Brexit is also important
But Brexit is also a very important part of this story.
If Brexit does prove to be a mistake, that should, all other beings equal, push the pound down. As we’ve already seen, a bigger trade deficit is bad for the pound. Of course, many ‘leave’ supporters argue that any lost trade with the EU can be offset by increased trade with other parts of the world. If that’s how things turn out, you might expect a stronger performance by the pound.
It’s also crucial to note that Brexit has had a significant impact on QE. Since the referendum, the Bank of England has cut the base rate again, and the Bank also started money printing again last autumn in an attempt to keep the UK economy moving after the Brexit shock.
Even if Brexit proves to be a success in the end, we face, at the very least, two or three years of uncertainty, and that lack of certainty may encourage the Bank to wind down QE at a slower pace than the US.
The long-term trend is down
However, even if Brexit works out well for the UK, there are still economic headwinds that could hit the pound over the next ten or fifteen years.
The two biggest headwinds are our trade deficit and low productivity. Our trading deficit is too high right now – even while we’re still members of the EU – and it’s been a problem for many years. Poor productivity has been another long-term problem for our economy, and there’s no sign we’ve figured out how to improve it.
Another issue is inflation. We have a poor record of keeping prices under control in this country even if inflation is still quiescent in 2017. History suggests that inflation can surprise and pick-up steam pretty quickly, so inflation may rise a lot more than markets currently expect.
Basically the pound has been falling since we left the Gold Standard in 1931. Back then it was over the $5 mark, and now it’s at roughly $1.30. There have been periods where the pound has fared reasonably well, but, over the very long-term, the trend has been down. I think that trend will continue.
What can you do?
One answer is to invest in assets that aren’t denominated in Sterling – so you could buy shares in other markets such as the US and Japan. It’s also important to note that the FTSE 100 has risen since the referendum because overseas profits by these FTSE 100 firms are converted back into Sterling at a lower rate.
It’s also worth considering putting some gold in your portfolio. History suggests that gold is a pretty good store of value that isn’t correlated to other assets. In other words, if the FTSE 100 dropped a fair bit next year, there’s a good chance that the gold price would move in a completely different direction. Gold is also normally seen as a good hedge against inflation.
I see gold as an financial insurance policy. At a time where the pound looks vulnerable and stock markets look ‘toppy’, it makes sense to invest in another asset that isn’t well correlated with most other assets. Gold also provides a bit of reassurance if you’re worried that Donald Trump may trigger a major war.
Don’t get me wrong, I’m not guaranteeing you that Gold will perform well when other assets decline. That’s because demand for gold is at least partly psychological. Gold is valuable because people think it’s valuable, and that popular perception may change.
That means it’s not the same as a pure insurance policy. There’s a good chance a ‘gold insurance policy’ will pay out when things go wrong, but no certainty.
So that’s why I’m bearish on the pound and reasonably bullish on gold. If you agree with me, you know what to do…
Previously the editor of the Motley Fool, deputy editor at MoneyWeek and presenter on Share Radio, Ed Bowsher is a freelance journalist and investment analyst
Statistics are taken from poundsterlinglive.com