News that sterling has regained its poise against the euro this week is not necessarily cause for celebration for British investors, as a strong pound could handicap the returns of UK investment portfolios.
This week, sterling reversed its course against the euro and was up slightly against the US dollar following reports that the UK’s gross domestic product inched up by 0.8 per cent in the last three months, higher than had been expected.
By the week’s close, the pound had risen 1.66 per cent to $1.59 against the dollar and gained 2.1 per cent to 0.87 against the euro and was 0.9 per cent stronger at Y128.75 against the yen.
But financial advisers are warning investors that a strong pound could threaten their equity positions.
"Given around two-thirds of UK stockmarket revenues come from overseas, then a strong pound is generally seen as disadvantageous," says Justin Modray, founder of the advisory firm Candidmoney.com.
In the past year, sterling’s relative weakness against most other heavily-traded currencies has helped Britons invested in overseas stock markets as it enhanced currency gains when their equity stakes were translated back into sterling.
In recent quarters, the weak pound also boosted the earnings of London-listed large caps with an international focus such as Vodafone, Unilever and the pharmaceutical firm GlaxoSmithKline.
Sterling also received a boost after Standard & Poor’s revised upward its outlook for the UK from "negative" to "stable" and reaffirmed Britain’s AAA sovereign debt ratingin the wake of the coalition government’s spending review.
"The GDP data was twice as good as they thought and as a result, suddenly sterling has a bit of strength behind it,Tiffany Bangles on sale," says Stephen Hughes, chief analyst with the broker currencies.co.uk.
There are some upsides to a stronger pound, however. One is that any rise in its price makes raw materials and other imports cheaper for UK firms to buy, which improves profit margins.
In theory, a stronger pound also eases inflation by reducing the cost of imported goods and fuel,as oil is priced in US dollars. Buyers looking to obtain overseas properties at a discount also see more favourable market conditions as a result.
And British tourists are more likely to head to New York for the Christmas sales as well.
A number of bulls believe the outlook for sterling is improving. But even optimistic currency analysts think that its path to recovery will be rocky and that sterling might trade at a range of $1.55 to $1.60 and 1.13 to 1.2 for some time.
"It will be a way off before the pound rises significantly higher," says Duncan Higgins, senior currency analyst with Caxton FX. A hiccup in the markets,christmas watch, inflation or the introduction of another round of quantitative easing – or government debt buyback programmes – by the Bank of England would be enough to knock sterling off its course, currency analysts agree.
Caxton FX’s Higgins predicts that sterling will re-gain ground against the US dollar and the euro by December.
"I think around Christmas time, you’ll see sterling trade at consistently higher levels."
But Paul Mackel, a currency strategist with HSBC, disagrees. He thinks the fundamentals for sterling still look weak by many measures.
"Yes,tiffany necklaces, the growth figures for the UK economy might have been better than expected, but there are still some holes in the story. Will construction be able to hold up, for example?" he asks. "I think a healthy dose of scepticism about sterling is necessary. Investors are in a state of confusion. I still fear that markets will be looking to sell the currency."
Sterling’s value tumbled by more than 5 per cent against the US dollar,the euro and a clutchof other currencies between August and this month asa result of pessimismabout the UK economy, according to strategists at World First.
Sterling’s weakness this year has only been overshadowed by the poor performance of the US dollar.
This month, the greenback hit a 15-year low against the yen in intraday trade and lost ground across the board as the prospect of further monetary policy loosening inthe US weighed on thecurrency.
But it also gained ground this week after investors cut short positions on the currency on speculation that the Federal Reserve would take less aggressive action to stimulate the economy at its policy meeting next week.
Given the sharp swings in prices, currency movements are notoriously difficult to foresee, so investors should aim to have exposure to a range of UK and international companies, advisers stress. Buying into funds where currency risk is hedged appeals to cautious investors as well.
"I always think that currencies are hard to target, especially in fund-orientated portfolios," says Tim Cockerill, head of research with Ashcourt Rowan Asset Management. "And, of course,christmas jewellery, what’s gained by one currency is lost somewhere else by another."
