Falling pound sterling – what it means for investors and savers

The pound has slid to an all-time low against the dollar, amid worries about the direction of the government’s economic policy.

The drop came after the new Chancellor Kwasi Kwarteng unveiled deep tax cuts and said there could be more to come. In the days after, it fell again following further economic criticism from the International Monetary Fund. The pound has continued to come under pressure, despite intervention in the markets by the Bank of England, which started buying bonds again to calm volatility.

The decline in pound sterling versus the US dollar

Source: Bloomberg, 28/09/2022.

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Tax cutting plans prompted the pound’s recent fall

These are the steepest tax cuts in 50 years. There’s nervousness because they’re unfunded and that means the government will have to borrow from international lenders.

There are also concerns the tax cuts will be inflationary, as they’re designed to give people more money to spend, on goods and services. That could mean that inflation will rise. Around a quarter of government debt is inflation linked, so it could also mean higher borrowing costs will be a burden for a lot longer.

As we’ve seen from the recent moves on the bond markets, with gilt yields rising sharply, investors are already demanding higher rates of interest to finance the government. There are some concerns that borrowing could become unsustainable.

UK two-year gilt yield (%)

Source: Bloomberg, 28/09/22.

Impact on spending and interest rates

The pound not only lost value against the dollar, but also against a basket of currencies. That means if you’re travelling abroad, your money won’t stretch as far and you won’t be able to buy as much.

A weaker pound can make the inflation headache worse because it increases the cost of imports priced in dollars like petrol, food ingredients, industrial components and electronic devices. This will mean prices on forecourts and in the shops are likely to stay higher for longer.

It’s also likely it will mean the Bank of England (BoE) will be forced to raise interest rates more steeply, so the cost of borrowing for businesses and consumers will rise.

There are now expectations in financial markets that interest rates could reach as much as 6% by the middle of next year, which will increase the cost of borrowing.

Usually, higher interest rates would boost sterling, but the events of the past year have shown that economic expectations can’t be relied on. The price of sterling is also dependent on the strength of the dollar, which has been bolstered by the flight into safe haven assets as economies around the world slow down.

UK estimated interest rates for December 2022

Source: Bloomberg, 26/09/22.

UK estimated interest rates for June 2023

Source: Bloomberg, 26/09/22.

Impact on the stock market

The impact on your investments will depend on what you hold and where those companies make their money.

The FTSE 100 tends to benefit from a weak pound. That’s because most big companies listed in London actually earn most of their money overseas, which will be worth more when it’s converted back into pounds.

However, concerns about slowing growth around the world are also affecting the prospects of some multinationals, so the effect of the weak pound on the index might not be so clear cut.

Lots of businesses that make money in the UK will face challenges. Retailers and other businesses who buy goods in from overseas face rising costs, due to higher import prices. They can try to pass the higher cost of imported goods on to consumers, or they can try to cut their operating costs. But the speed with which sterling has fallen could throw up more problems.

That's why the more domestically-focused FTSE 250 is likely to be more sensitive to a weaker pound. However, if growth is stimulated in the economy, that could help companies as more people will likely have more money to spend.

Impact on saving

There has been some good news for savers, with some of the best rates on the market rising significantly with rate expectations – especially in the one-year market, where you can now make around 4%. Given that the falling pound is likely to push inflation higher, it means it’s worth shopping around for the best possible deal, to help boost your savings growth as much as possible.

If you leave your money languishing in a high-street easy-access account, paying less than half a percent, runaway inflation will very quickly erode the spending power of your cash.

You should keep at least three to six months’ worth of essential expenses in an easily-accessible account for any emergencies. If you’re retired, that should be around one to three years’ worth. But anything over this could be put to work in a fixed-term savings product. These products will pay you more, but your money will therefore be locked away for longer.

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What about mortgages?

This week has also been fairly dramatic for the mortgage market, with a quarter of mortgages pulled from sale, while lenders waited for the dust to settle on the bond markets. Once things feel more functional, they’ll be back, but at a higher rate.

It could make life harder for buyers, who may struggle to borrow as much as they want once higher prices, higher rates and higher bills are factored into lenders’ affordability calculations. It could also cause difficulties for remortgaging. For anyone coming to the end of a fixed rate mortgage, if you have six months or less to run on your deal it’s worth shopping around for a new rate now, because you may be able to lock in a deal up to six months in advance and protect yourself from rises coming further down the track.

If you struggle to afford a remortgage at current rates, and you haven’t yet been through a cost-cutting process you may be able to budget your way out of the problem. Otherwise, it’s worth shopping around for the best possible deal to see if there’s anyone who can offer you something affordable.

If there’s simply nothing available at a rate you can manage, you can consider stretching your mortgage over a longer period. You’ll end up paying more in interest because you’re spreading the payments further, but it will make the monthly costs more affordable.

If you’ve exhausted every possible avenue, and you still can’t afford your new mortgage, you may need to start a conversation about where you can afford to live. However, there are an awful lot of things to try first.

What next?

Policymakers at the BoE are now in an economic tug of war with the government. The Bank wants to try to put a lid on demand to try and reduce inflation, even though it’s stepped in with a bond buying programme to calm immediate market volatility. On the other hand, the government wants to lift demand in the economy to try and promote its growth agenda.

So far, the Bank has shied away from bringing in an emergency rate hike. However, it’s stressed it won’t hesitate to change interest rates to bring inflation under control, returning the annual rate of price rises to its 2% target.

There are now expectations that at the very least, interest rates will rise by 0.75% at the next meeting, if not before. The Treasury’s also moved to calm markets, by promising more detail about tax cuts in a medium-term plan later in October. This will include an independent forecast of the economic effect.

It’s unclear if this will have the desired effect of supporting the pound. In the meantime, if it stays weak or drops further, it could increase the number of foreign buyers of UK companies. But also, the number of private equity firms circling targets hoping to nab a bargain.

This article isn’t personal advice. If you’re not sure what’s right for you, seek advice.