In the last six months, the pound has gradually weakened versus the world’s reserve currency, the US dollar. While in August last year £1 equalled as much as $1.57, today it equates to around $1.40. That’s a fall of over 10% in a relatively short space of time and puts the pound at almost a ten-year low versus the dollar, with it reaching a low of £1:$1.36 during the depths of the credit crunch.
Part of the reason for the pound’s weakening versus the dollar has, of course, been the strengthening of the greenback. The Federal Reserve decided to raise interest rates by 0.25% in December and this has the impact of strengthening a country’s currency.
However, in recent days the pound has taken a real hit and fallen at a rapid rate. That’s mostly because of the pending EU referendum, with there being a realistic chance that in less than four months’ time Britain will be outside of the EU.
The prospect of this brings great fear, since Britain leaving the EU would cause a huge amount of uncertainty for Britain (and for the EU), with it being an unprecedented event for which there is no blueprint. Therefore, it would be of little surprise for the pound to weaken further between now and the referendum – particularly if the exit campaign gains traction and has a realistic chance of winning.
Clearly, British exporters will be happy with the weaker pound since it makes their goods more competitive when sold abroad. With the vast majority of FTSE 350 companies which are based in the UK (and therefore report in pounds sterling) having significant foreign exposure, this could lead to a short term boost in their profitability.
Therefore, a weaker pound could be a good thing for earnings in 2016 and the FTSE 100 could gain a boost from increased demand for shares in companies which are enjoying a currency tailwind. And with exporters benefitting from a weaker currency and importers being hurt by it, the UK’s net exports should rise and provide the overall UK economy with a boost.
However, a weaker currency can also cause challenges, too. For example, it can cause inflation to spike since imported goods are more costly, while it can also have a major impact on monetary policy. With the UK’s interest rate being highly accommodative for such a long period, a weak currency could cause rate setters to become more hawkish and raise rates sooner than they otherwise would.
That’s because a weak pound could provide a turbo boost to the economy and mimic the effects of a low interest rate to some degree. And with the UK’s consumer debt levels still being exceptionally high, an interest rate rise may hurt consumer spending in the short run.
Clearly, a weaker currency is something of a double edged sword. However, for long term, Foolish investors, such movements are simply part of life as an investor. In other words, currencies fluctuate just as share prices do, with the simplest means of improving your long term financial outlook being to buy high quality stocks at fair prices.