Jonathan Marriott – Chief Investment Officer, LGT Vestra LLP
Will Brexit (ironically) bring about currency parity (1 GBP = 1 EUR)?
In some ways this question falls into two parts. Firstly, will the pound extend the falls we have seen since Brexit? And secondly, will the recent euro strength continue?
The biggest driver of movements in sterling over the last year has been Brexit. Immediately after the vote last year the pound fell sharply and, subsequently fell again in October as the government talked of a hard Brexit. Supported by a weak currency, and easing from the Bank of England (“BoE”) in the short term, the economy has performed better than many people feared.
However with a budget and trade deficit, foreign investment is important and without clarity on Brexit this is likely to be reduced. A falling currency is a double edged sword and the consequent rise in inflation above the rate of wage increases puts the break on consumer spending. With inflation up, the BoE has started to talk about taking back some of the stimulus measures it had originally put in place and two members of the Monetary Policy Committee voted for a rate rise at the latest monthly meeting. This has helped the pound to come off the lows against the US dollar. We believe that rates will be very slow to rise and that the BoE will use other controls to constrain borrowing for now. Talk of a softer Brexit with the DUP influence may be positive but a soft Brexit in many ways is harder to negotiate than a simple exit, and there appears to be little progress on this. With that said, despite any positives the pound has fallen further against the euro.
As the political fears seen at the start of the year about the rise of extremist parties has faded for now, the euro has since strengthened. The economy appears to be doing better than expected and the election of Macron in France, a strongly pro European Union candidate, provides hope of structural reform and greater stability. The European Central Bank (“ECB”) may be in a position to start to withdraw some of the monetary stimulus in the new year and make interest rates less negative. However, inflation continues to remain stubbornly low and a rising euro puts downward pressure on inflation, so the ECB may be slow to act. Political fears have not entirely gone away with Italian elections due sometime before the end of the first quarter of next year.
The outlook for sterling will likely remain dominated by Brexit negotiations for the foreseeable future and given the uncertainty of how these will pan out, it is difficult to forecast with any confidence. If it looked like a deal was possible on Brexit then a sharp reversal of part of last year’s move is possible but further decline towards parity with the euro is also possible.
With Dixons Carphone and Provident Financial facing difficulties this week is this just the start of profit downgrades for many of the FTSE domestic focused companies?
The problems at Provident Financial are very stock specific and related to regulatory investigation and changes in the way the business is run. As a result, we do not see this as a sign of a wider malaise in the UK. The turndown at Dixons Carphone, however, might be a sign of a wider problem for UK domestic retailers. The fall in the pound has raised the cost of imported goods and with wages rising slower than inflation it is hard for retailers to pass these price rises on. The rise in consumers buying over the internet has also made price comparison and dealing directly with suppliers easier, thus putting more pressure on margins. The Brexit negotiations add further uncertainty for UK companies that may see investments delayed. As we have stressed many times, the UK equity market has a large international component but companies with a domestic focus may struggle to perform well until there is greater clarity on Brexit and the inflationary impact of a falling currency comes out of the system.
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