At the end of last week, the pound reached its highest level against the dollar in almost three years, peaking above $1.37. Against the euro it had crossed €1.13, its highest in eight months.
In part, the pound’s recent rally comes down to growing optimism toward the UK vaccination programme. The currency was also bolstered by UK inflation figures, which showed a 0.3% rise in prices across December. Rising inflation makes it less likely that interest rates will fall, which is good news for the pound.
But while the currency’s gains against the euro have been relatively modest, the dollar tells a different story. Its success here speaks just as much of the weakness of the dollar as the strength of sterling.
A tough week for the dollarbuilds on a steady decline in its fortunes since May. Immediately after the virus struck, investors flooded to the US dollar in search of a safe haven to offset the surge in volatility. But since then, lowering interest rates across the pond and widespread market optimism heading into 2021 have made the currency less attractive to investors.
So, while the UK’s prospects look more positive than they did perhaps six months ago, in many ways a stronger pound is just a weaker dollar. That’s good and bad news.
Let’s start with the bad. For investments you hold overseas, the money earnt is now worth less in pounds than it was before.
And, surprisingly, the dollar slump could have a negative bearing on investments held closer to home. Investing in UK companies will more often than not involve having an exposure to foreign currencies, often the dollar - approximately three quarters of the earnings of the UK’s top 100 listed companies come from overseas. Those earnings are likely to be squeezed when converted back into pounds. All in all, a stronger pound is better news for smaller, more domestic-facing UK companies than it is larger ones.
It could also hurt UK exporters, who may find their earnings compressed as a stronger pound makes British goods more expensive to buy.
The flip side to this is what the pound tells us about market sentiment. Investors appear to hold the UK in higher regard now than they have in a long time. That’s in large part down to the removal of Brexit uncertainty. Regardless of how the deal looks, a resolution of any form was always going to make the UK a more attractive proposition to foreign investors.
That’s compounded by the speed of the vaccine rollout and tantalising glimpses of normality coming ever closer into view.
This is all good news for UK stocks. Even if a falling dollar may affect our overseas earners, the pain is likely to be offset by any wider market recovery.
The other caveat to the dollar/pound conundrum is that it may be more trouble that it’s worth. Currency movements are hard to trace at the best of times, let alone when things are moving as rapidly as they are now. Currency markets are volatile, and conditions can change quickly. Trying to exploit them requires an expert grasp and, often, a crystal ball.
Important Information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.