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Currency volatility: how it affects you

Paloma Kubiak
Written By:
Paloma Kubiak

Nervousness in the market fuelled by tumbling oil prices, China’s economic slowdown and the speculation around ‘Brexit’ has caused currency volatility around the globe. But what does this mean and why does it matter to you? YourMoney.com explains why currency volatility affects everyone.

Sterling has been weak since the start of the year, both against the euro and the dollar, though the euro pegged against the dollar has been pretty stable without much movement to date.

With speculation around the UK leaving the European Union – Brexit – and with the referendum set for June, we can expect further volatility to the pound as currency is the first thing that takes the strain amid market concerns, says James Illsley, a fund manager at JP Morgan Asset Management.

The currency is also being held hostage to the headlines surrounding an ‘in’ or ‘out’ vote and is “reactive around sentiment” of the perceived split, according to the latest exit polls.

As a result, we can expect sterling to remain weak over the next four months in the lead up to the referendum and after, Illsley adds.

To put the currencies into perspective, the value of the pound has slipped 5% from the start of the year, from £1=€1.357 to £1=€1.289 now.

Against the dollar, it’s now £1=$1.438, down from $1.47 at the start of the year (a 2-3% fall) and near a 30-year low shown by the Bloomberg Spot Rate.

Why does it matter and who does it affect?

It affects everyone whether they realise it or not,” says Illsley.

As consumers, we buy goods on the high street and these can be imported from overseas. While it doesn’t directly hit the consumer, currency fluctuations trickle down into the economy as a fall in the pound reduces the buying power in other currencies, such as exports.

It takes a while to work through the system but if sellers buy goods from abroad, it brings imported inflation into the economy and can lead to them changing prices in store as they’ll need to adjust their margins.

Holidaymakers heading abroad also don’t get as much bang for their buck, and new research this week showed that skiers and snowboarders have been the hardest hit, losing up to £112.53 per £1,000 this year in comparison to last year.

On the investor front, the source of revenue for most of the blue chip companies making up the FTSE 100 is “overwhelmingly international” (around 70% overseas compared with 30% from the UK) so a weaker sterling triggers a “mechanical upgrade in reported earnings”, Illsley says.

“In other words, because multinational FTSE 100 companies tend to operate with a large overseas presence, most will benefit from translating their earnings back into sterling in order to report to UK shareholders: a weaker pound acts as a near-term boost when reflected on their profits and loss.”

He gives the example of BP which will typically have its oil assets priced in US dollars. If pounds are suddenly worth less relative to the US dollar, the translation effect is more pounds for the same amount of dollar earnings – good news for investors.

In the wider context, international investors may be put off from investing in the UK as it would be a risk for them to put money in sterling ahead of the vote.

What can investors do to minimise currency shock?

It’s very difficult to predict currency movements and it will depend upon the outcome of the referendum.

However, Illsley doesn’t advocate changing your portfolio just on the Brexit murmurings and says this could actually prove to be very risky.

Clearly there are good companies that have good market positioning in spite of what the sterling is doing and so far, the weakness of sterling has been of benefit to the majority of blue chip firms.

The in-out referendum is scheduled on 23 June which is a “very short period to take a position on or reverse a position,” he says.

Though he adds there will be people who take a bet on sterling and some will be right while others will inevitably be wrong.

“I would focus on a company paying the right price and one that delivers investment objectives,” he says.

Diversification in a portfolio is always a good thing and this view is shared by Adrian Lowcock, head of investing at Axa Self Investor.

“I wouldn’t position a portfolio to respond to the outcome of the referendum. Instead be positioned for your own goals whether that is retirement or to invest for a dream home. I would suggest having a well-diversified portfolio exposed to global equities, including the UK, using funds which are actively managed which means you get exposure to well run businesses which should be better able to tolerate any economic downturn or weakness in the UK.”

Lowcocks adds that he generally likes UK equity income to achieve this as companies which are focused on returning profits to shareholders tend to be cash generative and well managed. A diversified portfolio will protect investors from the known risks but also from the unknown one’s, he says.

It’s difficult to predict, but what can we expect?

Lowcock expects sterling to remain weaker until the outcome is known. “After that it really depends on the answer. Any exit vote could lead to further weakness in sterling against the dollar but could also cause weakness in the euro if concerns over the EU’s future is thrown into doubt,” he adds.

Illsley agrees. If there is Brexit, sterling will continue to weaken against a basket of currencies but there will also be a wider range of issues as a result. He expects that sterling will recover, or at least regain some of the ground it’s lost if the UK votes to remain in the EU.