LONDON (Reuters) - Sterling has tumbled to a 31-year low, but British stocks are near a record high and, contrary to many expert forecasts, the shock of Brexit has not pushed the British economy off a cliff.
So what gives?
Depending on which part of the financial universe you look at, the outlook for UK Plc following the June 23 vote to leave the European Union can appear equally bright or bleak.
Sterling’s plunge makes Britain’s exports more competitive on global markets and is therefore a boost for economic growth. But if sustained, it will fuel inflation and become a source of worry at the Bank of England.
How does the rest of the world measure Britain’s standing as it prepares to divorce from the EU? Which is more telling: the steep decline in the currency’s value, or the recovery in the stock markets and competitiveness?
Below is a guide to what has happened across UK markets and the economy since the Brexit vote, what lies ahead and what it means for Britain.
For a weekly round-up of Brexit news: here
- CURRENCY: Sterling, which traded as high as $1.50 on June 23, fell below $1.27 for the first time since June 1985 on Tuesday, and sank further on Wednesday to hit a new 31-year low.
Sterling also fell to a 5-year low against the euro at 88.42 pence and a 7-year low against a basket of currencies of Britain’s main trading partners after a 13 percent depreciation since the Brexit vote.
Currency traders have shunned the pound on fears over Britain’s highly uncertain economic future, and the Bank of England’s decision after the referendum to cut interest rates and inject more bond buying stimulus into the system.
- SHARES: Britain’s FTSE 100 index rose above the 7,000-point level for the first time since mid-2015. The blue-chip index has risen more than 11 percent since its pre-Brexit level - and almost 20 percent from its post-Brexit low - and has come within a whisker of its historic high of 7,122.74.
The FTSE 250, which measures the value of smaller and more domestic-focused firms, hit a record high of 18,607 points this week and is up more than 20 percent from the post-Brexit low of June 27.
The rally in stocks has been fuelled by the BoE’s policy response and the slump in sterling. A weaker exchange rate boosts the earnings of companies with global operations, and around 75 percent of FTSE 100 firms’ earnings are derived from abroad.
By contrast, in dollar terms - which is how non-UK investors measure their results - the FTSE 100 is still 5 percent lower than it was the day of the referendum and the FTSE 250 is down 10 percent.
- BONDS: British government gilt prices have leapt to a record high on the back of the BoE’s decision in August to cut rates to a new low of 0.25 percent and restart its quantitative easing programme with a planned 60 billion pounds of purchases spread over six months.
Benchmark 10-year gilt yields reached an all-time low of 0.503 percent in mid-August - down from more than 1.3 percent before the vote - but have since pulled back and stand at just over 0.8 percent.
- MONETARY POLICY: The Bank of England cut rates on Aug. 4 to the lowest in its 322-year history and unleashed billions of pounds worth of extra stimulus.
The pound is likely to remain extremely sensitive to statements from Prime Minister Theresa May, her ministers and European leaders on how the Brexit process unfolds.
Lawmakers from PM May’s ruling Conservative Party say the fall in sterling has made Britain more competitive, but many financial market analysts say it reflects the negative view the rest of the world has of Brexit Britain.
The next major step in the Brexit process will be when May sends, by the end of March, a formal notification to the EU that Britain is preparing to leave, invoking Article 50 of the EU’s Lisbon Treaty. That starts a two-year negotiating window before the United Kingdom should leave.
Still, politics could intervene: the U.S. presidential election takes place on November 8, Italy faces a referendum on Dec. 4, France holds a presidential election on April 23 and May 7 and Germany holds an election in September 2017.
Just because the pound has fallen sharply in the last three months, there’s no reason it should automatically recover. Some analysts say $1.20 could be tested in the coming months.
BoE deputy governor Ben Broadbent said on Wednesday that sterling’s decline has so far been “pretty orderly, actually” and reflected markets’ longer-term judgements about Britain’s economy.
Central to Britain’s stock market direction in the coming months is the exchange rate. As long as the pound remains weak, equity valuations will be revised higher. If you take the view that sterling will remain weak, earnings will be higher.
UK stocks are trading in a binary fashion - sterling falls, stocks rise. And vice versa. There is no sign of a “buyers’ strike” hitting UK stocks or bonds right now because the BoE is happy letting the pound take the strain as it boosts exports, and helps narrow the trade and current account deficits.
The exchange rate moves also make British companies more attractive takeover targets for foreign firms, potentially fuelling a mergers and acquisition wave that would boost the value of UK shares.
But if, in the words of BoE governor Mark Carney, a country depends on “the kindness of strangers”, you have to be careful about your currency. There may come a point when foreign investors take fright at sterling and stop buying UK assets.
A Reuters poll of around 30 traders, fund managers and strategists this week predicted that the FTSE 100 will lose ground over the coming year.
The current consensus is that British-based companies that earn in currencies other than the pound - such as British American Tobacco, GlaxoSmithKline Plc - should do well as their revenues will be reported in pounds.
Those reliant on domestic revenues - such as retailers - are exposed should the British economy take a hit. While recent data has shown the economy shrugged off some the shock of the Brexit vote, the Bank of England downgraded its 2017 growth forecast to just 0.8 percent from a previous estimate of 2.3 percent. The growth outlook for 2018 was cut to 1.8 percent.
Supermarkets such as no.2 player Sainsbury’s have said sterling’s fall since the Brexit will not necessarily lead to higher grocery prices, as it could be offset by lower commodities prices and stiff competition. Travel companies TUI Group and Thomas Cook have seen bookings from UK customers rise this summer, as Britons defied worries that the devaluation of the pound would deter people from going on holidays abroad.
Economists estimate that a sustained 10 percent fall in the pound’s exchange rate adds about 0.2-0.3 percentage points to inflation over the period of a couple of years.
The Bank of England forecasts inflation will rebound to around its 2 percent target next year and then overshoot to 2.4 percent in 2018 and 2019 - the biggest medium-term overshoot it has ever forecast.
Some banks predict a bigger, but shorter-lived, spike in inflation next year as the effects of a weaker currency pass through more quickly to the rest of the economy than the BoE expects.
Retailers have given a mixed picture on how soon they will pass on price rises. Some, such as fashion retailer Next have said they plan to raise prices rather than erode margins.
But other sectors such as groceries see different competitive pressures.
While the fall in sterling should make imported food more expensive, Britain’s biggest retailer, Tesco, sees no let up in deflation in the UK grocery market any time soon.
A survey published by the British Retail Consortium reported a record drop in the cost of food and found little sign of price rises on the back of sterling’s fall since the Brexit vote.
The shock vote to leave the EU chilled dealmaking activity involving British companies to the lowest level in at least two decades as bosses grapple with what Brexit will cost, Thomson Reuters data shows.
The Bank said in August and again in September that most of its policymakers expected to cut rates again this year if the economy looked on track to slow as it had forecast.
Stronger than expected recent data puts it in a tricky position. While weakening the immediate case for a further rate cut - especially as soon as next month - it is less clear whether it will alter the BoE’s longer-run expectation of a slump in business investment and a gentler slowdown in consumer spending.
BRITAIN‘S PLACE IN THE WORLD
The United Kingdom’s gross domestic product, forecast before the June 23 vote to be worth about $2.8 trillion in 2016, or the world’s fifth largest, has now slipped behind France.
Its GDP is now worth about $2.32 trillion on current exchange rates, compared with France’s $2.34 trillion. Germany is the EU’s largest economy, worth about $3.5 trillion, and the world’s fourth largest economy after the United States, China and Japan.
Writing by Jamie McGeever, Guy Faulconbridge, David Milliken, Sarah Young; Editing by Robin Pomeroy