Investment Clock insights

Could a base rate hike hurt the pound?


Trevor Greetham, Head of Multi Asset

10 October 2017

While US interest rate expectations have been firming up, the recent weakness in the pound has been far larger than can be explained by interest rate differentials between the UK and US alone (chart 1). A pick-up in sterling exchange rate volatility (chart 2) suggests political risk is to blame, with Theresa May’s weakened position after the Conservative Party conference increasing risks around the Brexit negotiations.

In our multi asset funds, we are underweight sterling and UK equities, which are approaching their all-time lows versus the world when taking sterling weakness into account (chart 3), seeing better equities opportunities in the emerging markets and in Japan.

Bond markets expect the Bank of England to hike rates in November but the currency markets may be starting to see this as a policy mistake. Currency traders have long experience of emerging market central banks hiking rates to defend their currencies when they are selling off on political grounds. Such a move can be counterproductive if rate hikes weaken the economy.

The Bank of England may find itself in the same credibility trap if interest rates rise while Brexit outcomes are unclear and economic data is soft.

 

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.