A Weak Pound: Advantages, Disadvantages, Investing Tips

How does a weak pound affect investors, businesses, and the UK economy in general? What are the advantages and disadvantages?

The weaker pound makes British exports more competitively priced and attracts foreign investors. It also boosts tourism by making it more affordable for international travelers.

It opens up some investment opportunities as well. For instance, fine wine that’s denominated in pounds will be cheaper for foreign buyers now.

But, the downsides are soaring inflation and the higher cost of imported foreign goods, among others. 

Let’s explore the weak pound advantages and disadvantages, how it affects investors, how to protect your portfolio, and a smart investment alternative. 

We’ll also cover what influences a country’s currency, why the pound sterling fell, and how the government responded. 

Advantages of a Weak Pound

These are some of the advantages of a weaker pound sterling:

1. Stimulates Net Exports

A weaker currency can increase the price competitiveness of UK exports on the foreign market. Since the value of the pound is lower, foreign buyers will pay less for goods from the UK. This may contribute to increased export sales and international trade. 

2. Opens Up Investment Opportunities for Foreign Investors (E.g. Fine Wine)

This might not be a good time for UK-based investors to invest in global equity funds or US shares. But, foreign investors could consider UK-listed firms that earn most of their revenues in US dollars. 

Besides, some collectibles like fine wine could also be cheaper during this time for US investors. 

How?

Fine wine is bought and sold in British pounds. Today, the US dollar buys 27% more in pounds than it did a year ago.

Why is this great news for wine investors buying in US dollars?

Fine wine prices are continuing to soar. But if you’re buying wine in US dollars, you can do so for 27% less today than you would have when the pound was at its peak. 

Moreover, the finest wines typically deliver stable returns that aren’t correlated to conventional investment assets. 

For instance:

• The Liv-Ex 1000 index, which tracks wine prices, grew by 19.08% in 2021.
• In 2022, it increased by 6.9%.  
• Five-year returns (June 2017— June 2022) reached 50.3%.

With wine prices continuing to surge, this is an ideal opportunity for buyers.

3.Boosts tourism

A weaker pound also increases the real purchasing power of people visiting from a foreign country, boosting international tourism. This will contribute to the economy by increasing aggregate demand (the demand for goods and services in an economy).

4. May Contribute to a Rise in the FTSE100 Index

A weaker currency can contribute to an increase in the FTSE100 Index  (the share index of the 100 companies listed on the London Stock Exchange with the highest market capitalization). For instance, the index hit 8,000 points in Feb 2023 — a record high.

There’s an inverse correlation between the pound’s performance and the UK’s stock market index (FTSE100). Weakness in the pound sterling generally benefits big UK exporters listed in London, such as GSK, Diageo, and Coca-Cola. 

This is because most large companies listed on the London stock exchange generate a large portion of their revenues overseas. So when converted back to pounds, those profits will be higher.

Disadvantages of a Weak Pound

Here are the two main downsides of a weaker pound:

1. Higher Inflation Negatively Affects UK Consumers

The depreciation of domestic currency results in higher inflation, which reduces the real purchasing power of UK consumers. 

Imported goods, including food and fuel, also become more expensive for people in the UK. 

2. UK Businesses May Suffer Due to Higher Cost of Goods 

UK-based businesses will have to pay more for raw materials and foreign goods that they import due to the lower value of the pound. In turn, this will directly affect their bottom line. 

How Does the Weak Pound Affect Investors?

Let’s examine the effect of the weaker pound on stock market investments and savings:

1. Stock Market Investments

The impact of the weaker pound on your investments depends on the company stocks you hold and, more specifically, where those companies operate. 

Most companies listed on the FTSE 100 generate their revenue overseas. So the profits they generate abroad have higher value when converted back into pounds. 

On the other hand, if the companies you’ve invested in operate within the UK, your investment may be negatively affected. As the purchasing power of UK-based consumers declines, locally-based companies will either have to increase their prices or suffer revenue losses.

2. Savings Accounts

On 2 February 2023, the Bank of England raised the interest rate to 4% in an effort to counter the effects of government tax cuts and the falling pound. 

The higher interest rate benefits people with savings accounts, as they can earn more interest. That’s why it’s better to shop around for high-interest-bearing savings accounts rather than opt for an easy-access account that typically only pays half a percent. 

Remember, if the account you choose pays low-interest rates, inflation is likely to erode the spending power of your money. 

Next, let’s discuss how you can protect your portfolio. 

What Can Investors Do To Shield Themselves from Currency Risk?

Investing in various asset classes and globally dispersed markets can help mitigate risks associated with the fall of one particular currency. 

You can diversify your portfolio by investing in:

• Alternative investments
• Local and international companies
• Commodities
• Broad based currency ETFs

1. Alternative Investments like Wine

Diversifying your portfolio with alternative investments can help you shield against the falling pound and the turbulence of the traditional market. 

Alternative asset markets are typically driven by internal factors rather than international financial markets, making them less susceptible to changes in a particular country’s currency. 

Alternative investments like fine wine, gold, art, and real estate tend to perform well even during times of high inflation. 

2. Local and International Companies

If you’re an investor based in the UK, ensure that your portfolio covers a diverse range of companies based both locally and abroad. 

That way, when the pound weakens, you can benefit from companies that generate revenue overseas in other currencies.

Similarly, when the pound picks up, you can benefit from companies that make their money locally. 

3. Commodities

Another way to shield your portfolio against depreciation in the pound’s value is to invest in commodities, particularly metals, energy, livestock, and agriculture products. 

Commodity prices typically rise when inflation accelerates. So these investments help hedge against inflation caused by a decline in the pound. 

4. Broad Based Currency ETFs

An ETF (Exchange Traded Fund) is a type of pooled investment security that operates like a mutual fund. ETFs track a particular index, sector, or commodity. 

A currency ETF is a pooled investment in foreign currency or forex (foreign exchange).  

A broad based currency ETF invests in a range of foreign currencies. So when certain currencies do badly on the foreign exchange market (e.g., a weak dollar or pound), others may be doing well (e.g., a strong Euro or Australian dollar). 

Ultimately, investing in other currencies can help offset losses caused by a falling exchange rate. 

Now, let’s take a step back and see what caused the pound to crash, what the government did, and what factors influence a currency.

What Influences a Country’s Currency?

To understand what influences the value of money, it’s important to note the two currency types :

• Fixed exchange rate currencies: The value of these currencies is directly connected to another stronger currency. 

For example, Aruba, a developing country, has a fixed exchange rate linked to the US dollar. Similarly, the Danish krone is linked to another strong currency - the Euro. 

• Floating exchange rate currencies: The value of currencies with a floating exchange rate is determined by the market (for example, the British pound). 

Here are the factors that influence the value of a floating exchange rate currency, like the pound or the dollar:

• Investor Confidence and Speculation
• The Central Bank Interest Rates
• The Cost of Goods Within the Country
• Amount of Government Debt
• A Trade Deficit

1. Investor Confidence and Speculation

A currency is affected by investors and commentators who speculate about whether a country is investment-worthy. 

These speculators buy and sell currency based on predictions of future events. If they speculate positively about the country’s economy, it can push up the value of the currency. If they have negative expectations, it can have the opposite effect.  

2. The Central Bank Interest Rates

When interest rates increase, investors holding local savings accounts or bonds receive higher returns. 

This typically attracts foreign investment, increasing the demand for and value of the home country's currency.

3. The Cost of Goods within the Country

If the price of domestic goods is lower than abroad, it makes the country an attractive investment destination for foreign investors — since they can purchase assets like gold or stocks at a lower price. 

When a significant amount of foreign investment comes into the country, its currency value increases.   

4. Amount of Government Debt

Countries typically borrow capital to pay for public sector projects and governmental funding. But a country with excessive debt is less attractive to foreign investors. 

This is because large-scale government debt leads to increased inflation. Subsequently, a high inflation rate is a deterrent to investors and can result in a weak currency. 

5. A Trade Deficit 

A trade deficit is when a country purchases more goods than it sells. 

When the value of imported goods exceeds the export value of goods, there’s less demand for that countrys currency on the foreign market. This imbalance weakens a country’s currency exchange rate. 

What Caused the Pound to Fall?

Here are the main reasons for the weaker pound: 

1. Plans to Reduce Taxes

The British pound first began to decline when the government announced plans to cut taxes. 

The UK government’s monetary policy caused investors to panic. This negatively impacted the UK economy.  

The International Monetary Fund (a financial agency of the United Nations) and international investors condemned the government’s plans for two reasons:

• Tax cuts were unfunded: The monetary policy involved borrowing money from international lenders to make up for the lost tax revenue. 
• Tax cuts would drive inflation: A substantial portion of British government debt is inflation-linked. When inflation rises, investors lending money to the government through bonds will require higher repayment interest rates. This could make government borrowing unsustainable. 

2. Higher Energy Prices Due to the War in Ukraine

The war in Ukraine led to Western sanctions against Russia.

This prompted Russia to reduce energy deliveries to some states, leading to energy security concerns in the United Kingdom and other European countries. 

Limited access to Russian commodities and other market forces increased oil demand. This caused petrol and diesel prices to rise in the United Kingdom. It also affected overall economic activity and contributed to an increase in the cost of living and inflation.  

3. Brexit

Experts suggest that Brexit has contributed in multiple ways to the depreciation of the British pound. 

Here are two of the main reasons:

• Decline in immigration from the European Union: Prior to Brexit, the British labor market was characterized by low unemployment and satisfactory levels of economic immigration. 

Brexit led to labor shortages, especially in hospitality, healthcare, and science, which significantly stunted economic growth.  

• Inability to renegotiate key trading deals with the EU: Since the UK is reliant on imports from the EU trading bloc, the inability to renegotiate deals led to higher food and gas prices. This contributed to higher inflation, which weakened the pound.  

How the UK Government Responded

The British government announced plans to cut taxes. In response, the Bank of England (the equivalent of the Federal Reserve in the US) raised interest rates more aggressively. They hoped this would help curb inflation and promote economic growth. 

Higher interest rates typically have a cooling effect on the economy as it makes borrowing more expensive.  

Next, let’s see how you can make the most of the weak currency by investing in fine wine. 

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