How does a weak pound affect my investments?

Most people only think about exchange rates when they’re about to go on holiday. But changes in a currency’s value can have far-reaching implications that stretch beyond the cost of travel. 

Here, we consider the factors dictating a currency’s value and who benefits from a strong or weak pound.

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Investment management advice

Stocks and Shares Investment ISA

What affects a currency’s value?

The first thing to understand about exchange rates is that they are relative – they reflect the price of one country’s currency in terms of another country’s currency. For example, on 28 April 2005, the value of the pound versus the dollar (the GBP/USD exchange rate) was 1.91, which meant £1 was equal to $1.91. By 7 April 2021, the exchange rate had fallen and £1 was equal to just $1.38¹.

Some of the factors influencing exchange rates include:

• Inflation: countries with low inflation typically have stronger currencies than those with high inflation. This is because low inflation gives a currency greater purchasing power. 
• Interest rates: high interest rates boost returns on asset classes like bonds and gilts. This can help to attract foreign capital, which bolsters the local currency. 
• Economic and political stability: a politically stable country which has a solid, growing economy will attract foreign investment. This helps to increase the demand and value of the country’s currency. 

Why is the pound weak?

The value of the pound versus the dollar has been on a downward trajectory for much of 2022. UK inflation has soared and fears of a recession are growing. When the Bank of England warned in May of a contraction in the UK economy, the pound hit its lowest level versus the dollar since the onset of the pandemic. (Its biggest-ever one day fall was in June 2016 when the UK voted to leave the EU.)

The US dollar is relatively attractive because it is by far the biggest reserve currency for the global economy. In other words, it is the main currency that countries hold to weather economic shocks, pay for imports and service debts. As a result of being the world’s reserve currency, the dollar is seen as a safe haven in uncertain times.

How does a weak pound affect my investments?

A decline in the value of the pound might seem worrying, but it isn’t all bad news. A weaker pound is positive news for UK businesses who export goods overseas because those goods become cheaper to foreign buyers. This can help to increase sales. 

A weaker pound can also lead to a rise in the FTSE 100 Index because around 70% of FTSE 100 company revenues come from overseas. A large proportion of that revenue is denominated in US dollars. When the pound falls in value, those dollar earnings buy more pounds when exchanged back into sterling, making those revenues more valuable.

On the flipside, a weak pound is damaging for UK importers and manufacturers with supply chains overseas. This is because the purchasing power of their pounds is reduced.

It also tends to push up inflation because the UK imports more than it exports. So, a weaker pound will make goods more expensive for both companies and consumers. Anyone on a fixed income, like many pensioners, or workers who have not had a pay rise in several years, will be hit especially hard because inflation eats into the purchasing power of their income, effectively making them poorer.

How can I protect my portfolio?

Just like any market movements, currency movements are extremely difficult to predict. They are also only one factor that influences investment performance. Basing your investment decisions on foreign exchange rates could end up costing you dearly. It is far better to stay focused on your long-term goals and ensure you have a diversified portfolio that spreads your money across different asset classes and regions. 

Building a diversified investment portfolio on your own isn’t easy, and that’s where getting some smart advice can help. An adviser will ensure your portfolio is built to withstand economic shocks and works hard to preserve, and grow, your money’s purchasing power over the long term. You can feel confident you’re on track for a secure financial future, whatever is happening in the wider economy.