Are Low Interest Rates and a Falling Pound Good News for Investors?
October has seen the UK stock market soar and sterling fall to a 31-year low against the dollar following the bank rate being halved to 0.25%. These three events are all interconnected.
The Bank of England cut interest rates in August and suggested further reductions may follow, putting downward pressure on the pound. On 2 October, Theresa May announced the Government would trigger the process of leaving the EU by the end of March 2017. Other comments, relating to the restriction of EU immigration, caused a growing concern that Britain may leave the single market. Large numbers of investors transferred their exposure away from the uncertainty of sterling to more reliable currencies, such as the dollar, causing the pound to fall further. Many of Britain’s leading companies, most of which earn their revenue in dollars, saw their share value surge, taking the FTSE 100 index almost to the record high reached in April 2015.
Repercussions across all asset classes
International companies listed on the FTSE that mine or sell commodities typically borrow in pounds but earn in a relatively strong currency, such as dollars. This cuts the cost of servicing the debt, which makes the company more attractive to investors.
As well as the FTSE, other beneficiaries of the falling pound include overseas tourists and investors. The UK has suddenly become a cheap place to visit – and anyone with dollars and euros in their pockets will find UK assets, such as property, even more attractive than it was previously.
Once the short-term concerns that are causing the pound to fall have been addressed, sterling will most likely climb, though not necessarily to its pre-Brexit levels. So investing in sterling now while the price is depressed could provide lucrative opportunities to sell in the future. Such a course of action could, in turn, cause the FTSE to fall. So it may be a good time to sell shares and look towards more stable alternatives during this time of uncertainty.
The low interest rates and falling pound are feeding through into other financial markets. Government bonds, for example, are seeing their yields rise. Government policy designed to curb possible inflation caused by the fall in sterling could result in better rates for savers and improved returns on pension funds that invest in bonds.
While it is true that interest rates can’t fall much lower (though negative rates are a possibility) no-one can be sure where the pound will head from here. In these times of uncertainty, it is prudent to assemble a diverse spread of investments, encompassing different countries as well as different asset classes.