By Michelle McGagh of Citywire
Most financial experts remain gloomy about prospects for the pound, despite this week’s spike in sterling following Theresa May’s Brexit speech.
The pound shot up more than 2.6% on Tuesday to $1.23 against the dollar, its biggest jump since the financial crisis.
It has continued to rally against the dollar and other currencies as traders digest the prime minister’s two messages: on the one hand stating her readiness to accept a ‘hard’ exit from the European Union if talks to retain some access to the single market fail; on the other, stressing Britain would remain a ‘best friend’ to the EU.
The currency’s positive response lifted the pound off the near 32-year lows it plumbed after the shock EU referendum result last June. Although sterling was arguably due a boost after its post-ballot battering, the move nevertheless puzzled David Jane of Miton Asset Management.
‘In the short term moves are being driven by sentiment around Brexit. How this might pan out can be argued both ways at present. On the positive side the market may now be discounting a full, hard Brexit given recent events.
‘Conversely, the uncertainty that is inevitable from the no doubt difficult and protracted negotiations might be argued to add further weight on sterling. Take your pick,’ Jane said.
Other investors doubt the pound has turned a corner, which if you are an investor who doesn’t go on foreign holidays is probably a good thing. The weakness in sterling has been a prime factor in the UK stock market’s recent record two-week run of all-time highs, which have extended the referendum rally.
This is because a fall in the pound boosts the value of overseas profits earned by many of the big multi-nationals in the FTSE 100.
David Shairp, head of research at Prudential, the investment and pension group, said this week’s rally was not a sign of a longer-term rally in sterling. He said it reflected investors ‘taking profit in underweight sterling positions’ and was a ‘short term move rather than a massive turning point’.
Although May’s speech was important, he believed an earlier speech by Bank of England governor Mark Carney helped to steady the pound and provided a ‘balanced assessment’ of Brexit options.
Carney hinted a more hawkish stance was possible with interest rates rises under consideration if inflation became a problem due to the low pound making imports into the UK more expensive. ‘It let the market see it was not all one way,’ said Shairp.
Alex Scott, deputy chief investment officer at Seven Investment Management, was also sceptical about whether the bounce in sterling marked the end of a difficult period for the currency.
‘There are still risks to both sides,’ he said. ‘We are in an environment where there is a great deal of uncertainty but we do have a little more clarity about the government’s objectives and process [regarding Brexit].
‘Markets in particular seemed to be responding to the announcement that there will be a parliamentary vote at the end of the two-year [Brexit] negotiation phase and that opens up a range of possibilities.’
Scott added that the direction of sterling would depend on the ‘progress of the economy over the next six to 12 months and whether concerns about the impact of Brexit coming home to roost start to undermine the economy’.
Joshua Mahoney, market analyst at trading platform IG, agreed the rally in sterling was ‘counterintuitive’, sparked ‘by the one thing everyone has been dreading: a hard Brexit’.
However, he believed May’s tough approach to EU negotiations was good for the pound and that the rally could signal a more durable revival.
‘[It] could very well mark the beginning of the end for sterling weakness, for May’s bold approach has put everything out in the open, thus reducing the likeliness of further sterling sell-offs each time anything remotely resembling a hard Brexit is brought up,’ he said.
‘With everything out in the open there is a good chance we will see the pound start to recover from here on out.’
The downside of a strengthening pound would be the impact on the FTSE 100, which has greatly enjoyed the boost to its big dollar earners. This could mean ‘the FTSE may be on the cusp of a significant downturn,’ said Mahoney.
Scott agreed the performance of the FTSE over the past year was ‘built on fairly fragile foundations of a weak pound’ and this ‘money illusion’ made investing in the index less attractive.
‘The FTSE is not looking nearly so attractive in dollar or euro terms,’ he said. ‘I think that remains the case…a strong rally [in the pound] will blunt the FTSE.’
Ken Odeluga, market analyst at City Index, said the FTSE 100’s recent winning streak could be at an end but thought a period of sideways trading was more likely than a major downturn.
‘With such tailwinds as the continuing oil price rebound, resilient consumption, and even the moderation of strong-dollar concerns as the “Trump trade” fades, the FTSE is more in line for a pause than a new downtrend,’ he said.