When sterling flirted with parity with the dollar in 1985, mobile phones were a novelty and an average UK house cost just £30,000. The pound at $1.14 is still nearly a tenth higher than it was then. There are parallels nonetheless.
Then, as now, sterling’s slide was largely caused by the dollar’s strength. Investors also worried about the government’s fiscal probity. The arrival of Liz Truss at Number 10 has revived those fears. The new government has promised to cap gas prices. It is expected to deliver a tax-cutting mini-Budget on Friday.
The weak pound is bad for companies with heavy dollar-denominated costs. ABF, owner of fast-fashion chain Primark, has warned on profits because clothes mostly sourced in Asia are denominated in dollars. A wider group of businesses is hurt by inflation fuelled by the weak pound. As well as raising input costs, it cuts consumers’ spending power.
But investors can also benefit. A weak pound helps foreign acquirers to pay big premiums. It flatters the results of many FTSE 100 companies which overall make over two-thirds of their sales and profits outside the UK. Consider Relx. The academic publisher generates three-fifths of its revenues in North America. Its first-half revenues rose 17 per cent in sterling, compared with 13 per cent in constant currency terms.
Britain’s biggest defence contractor BAE is particularly sensitive. Every 5 cent movement of the dollar shifts earnings per share, which totalled 47.8p last year, by one penny.
Hedging blunts the impact, but it can cause problems. Rolls-Royce makes extensive use of hedging because of the mismatch between its dollar receipts and sterling costs. When the pandemic grounded airliners, the engine maker found itself over-hedged. A £1.7bn unwind will reduce cash flow until 2025. Rolls now plans to carry a smaller hedge book and register the impact of currency movements sooner.
In 1985, big economies struck an agreement to halt the dollar’s meteoric rise. That is not on the cards this time round. Some investors, such as Pimco co-founder Bill Gross, think an overvalued dollar will fall naturally.
But pressure on sterling could be prolonged if the UK government experiments with unorthodox economics or risks a trade war with the EU over the Northern Ireland protocol. In those circumstances, expect sterling — and businesses exposed to currency gyrations — to take a pounding.
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