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Stop panicking about the Pound…it is now too cheap

‘A pound of pluck is worth a ton of luck’ - James A. Garfield

Wise advice above but a British Pound’s worth of pluck is not worth what it used to be in euro or dollar terms. When your home currency is battling with the much maligned Argentine peso to be only the second-worst major global currency performer during 2016 then you know it is out-of-favour. To put some numbers on this you have to go right the way back to 1985 to find a lower Pound-US dollar exchange rate than today’s meanwhile against the euro the Pound is down to levels last seen in 2011. I hope you do not need to buy some foreign currency for a getaway break anytime soon.

Consensus is that it is going to get worse. There are various theories why the Pound has fallen so sharply in recent days but fears of the impact of a ‘hard Brexit’, concerns of tensions between the UK government and the Bank of England plus a growing realisation that 2017 will economically be an uncertain year for the UK economy have all be cited. I see thoughtless computer trading has also been thrown into the mix. Meanwhile investment banks are starting to compete with each other to have the lowest target for the Pound.

Back in 1985 this manifested itself in investment calls anticipating parity between the US dollar and the Pound…in reality however the next stop for the Pound was two US dollars and not one. As always pessimism peaks just before the turning point.

And this will happen again. All of the above economic and financial market criteria overhanging the Pound are legitimate and real – but also widely known. There is certainty in the uncertainty! An exchange rate relates not to just one currency but two and the corollary to today’s weak Pound is a stronger euro and a stronger US dollar. For these two currencies – and others around the world – to be persistently stronger against the Pound their local economies are going to have to do better…persistently. You see longer-term currencies follow big economic trend criteria like growth, productivity and competitiveness all nicely captured in a metric called Purchasing Power Parity (PPP). When you look at the PPP numbers generated by the big supranational institutions like the OECD and the IMF they suggest that fair value for the Pound is around 1.45-1.50 against the US dollar and about 1.12 against the euro.

Despite the fog around the upcoming US Presidential election maybe the relative strength over recent years of the American economy does justify a stronger dollar but – at current exchange rates – a 15% stronger US currency is hard to justify. Even at current exchange rates you will soon hear US exporters squealing in pain.

Against the euro the Pound has fallen to around fair value. You will all have your own views on the relative direction of the Eurozone and UK economies but in my view both are clouded by uncertainty – and the UK has a much better economic track record over recent years. Certainly no reason for the Pound to slide further against the euro. You could say the same for Sterling against the Japanese yen or Chinese yuan.

What I am trying to say here is that the panic in the Pound is overdone. You cannot ignore the political uncertainty around Brexit and related but financial markets have the trait of selling first and asking questions later. If you dig behind the excitable headlines your Pound will be firmer against pretty much any currency you might like to mention this time next year.

Good news for any summer 2017 foreign holiday currency requirements you may have!

Chris Bailey has 20 years of investment industry experience at long-only and long-short institutions as a global multi-asset fund manager, strategist/macro thinker and, in the earlier part of his career, as a securities and fund analyst.

In 2013 he founded Financial Orbit focusing on daily macroeconomic comment and securities analysis.

The content on this page does not constitute financial advice and is provided for general information purposes only. Nothing on this page should be regarded as an offer to conduct investment business or to buy/sell any investment

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