When the FTSE 100 crashed below 6,000 straight after the EU referendum shock, few would have expected it to be flying so high just six months later. But here we are, going into Christmas, with the benchmark index above 7,000, a few festive high jinks away from its all-time high.
A right pounding
The Brexit shock didn’t last long. Investors quickly realised there was a bright side, which was that sterling was crashing at an even faster pace. On 22 June, when Britons went to bed expecting most of us to vote Remain on June 23, the pound topped out at around $1.49 and âŹ1.30. By mid-October, it had slumped as low as $1.21 and âŹ1.10, a peak-to-trough drop of almost 19% and 15% respectively.
This was good news for the FTSE 100 because companies listed on the index generate more than three-quarters of their revenues overseas, and the value of these earnings had soared once converted back into sterling. Better still, their exports were cheaper for foreigners to buy, which should also lift sales.
Dollar delight
There was a further boost for investors, because an astonishing 47 FTSE 100 companies pay dividends in dollars, which makes those payouts more valuable in sterling terms. Some, notably Unilever, pay in euros. Also, companies with large foreign earnings need to use less of them to maintain their dividend. There’s a downside to the weaker pound in that imported raw materials will become more expensive, pushing up company costs in sterling terms.
There’s another reason the FTSE 100 has done so well. Step forward US President-elect Donald Trump, whose much-hyped $1trn reflation blitz has given markets an extra lift, even though it’s far from set in stone.Â
Pound to rebound
This is one of the benefits of having a free-floating currency, which can help to act as a shock absorber, even one as big as Brexit. The pound has done its work, and is now taking a breather. Sterling is starting to recover, and currently trades at $1.24 and âŹ1.19. This is well below its pre-Brexit highs but is a marked improvement, especially against the single currency.
There may be more to come in 2017, with Bloomberg recently naming the pound as one of three global currencies to watch next year, along with the Norwegian krone and South African rand. It says technical charts and supportive cross-asset themes signal sterling’s recent momentum may continue.
Hard facts of life
Making predictions is always dangerous, especially about future currency movements. Much will depend on how markets react when Article 50 is triggered, presumably by the end of March, and whether negotiations progress in a cordial manner, or descend into acrimony.
Hard Brexit will hurt the pound, soft Brexit will help it, at least in the short run. When Theresa May made her “Brexit means Brexit” statement the pound slumped, but recovered after the Supreme Court gave Parliament a say, and Ministers started talking about transitional arrangements.
For now, the pound seems to have found its floor. In technical terms, it’s undervalued, but markets also have to price-in wholly unknowable political risk. The pound has done sterling work this year but we can’t rely on it repeating the trick in 2017.