The pound reached a record low against the dollar, Euro and other currencies last week, understandably causing alarm to the UK public.
Why has this happened?
Recent weakness was compounded by the Chancellor’s tax cutting mini-budget and investors around the world took the view that the UK government will need to borrow more to fund its plans, potentially jeopardising the goal of boosting the UK economy. In an attempt to rescue matters, the government has now reversed the scrapping of the 45% tax rate and the Bank of England has stepped in to help settle markets. Despite all of this, sterling is still cheaper than it was a month ago.
How does a weak pound affect me?
Very simply, the price of goods and services imported into the UK will go up. Importers might pass these costs onto UK customers and buyers of American products will likely see higher prices. This extends to gas and petrol, both of which are linked to the dollar and clearly overseas travel will be more expensive, especially trips to the US.
This added pressure on prices is likely to drive inflation. Many expect the Bank of England to respond to this threat with yet higher interest rates. The two million or so in the UK on a tracker or variable mortgage plus others on fixed deals due for renewal would see their repayments increase and banks will be less keen to lend to first-time buyers.
How does this affect my (UK) investments?
UK investors in sterling denominated global funds that are not hedged should expect a slight boost to returns in the short run, though currency movements tend to be neutral in the long-term. This effect was seen in 2018, when a weakening pound against the dollar added about 3.9% (measured by the difference between the MSCI All Country World IMI Index in local returns vs. GBP).
Currency changes are one of countless factors that move stock-market prices day to day. Currency volatility can be eliminated by hedging to sterling, though this adds to investment costs and does not meaningfully dampen volatility or improve returns in the long run.
Bond portfolios are normally much more modest and stable and so holdings are typically hedged to the investor’s home currency to keep volatility under control and avoid any gains being wiped out by currency fluctuations. However, even hedged bond funds have seen extraordinary price movements this year so far.
UK government bonds have suffered most from the weakening pound, though the Bank of England’s recent plan to purchase bonds worth up to £65bn has helped to settle markets. Globally diversified bond investors should take some comfort that the UK makes up less than 4% of the world market.
Overall, the weakening pound alone should have a minor effect on globally diversified investors compared to other factors such as inflation and the war in Ukraine.
What action should I take?
Markets are very unpredictable in the near-term and reward those who can weather the storm and hold on for more positive years. This is especially important for global bond investors, as bonds are much cheaper than they were a year ago but the expected return they will earn going forward has increased considerably.
Our team is on hand to help during these times, if you would like to discuss your worries in more detail, please contact us.
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