In the three months since the European Union referendum in the UK, there has been little impact other than the change of Prime Minister and the weakness in Sterling.
The FTSE 100 recovered quickly and even the FTSE 250 has regained its pre-vote levels, confounding the warnings from a range of experts. However, performance has diverged between companies with substantial overseas earnings and those which are more domestically-exposed.
Brexit will take several years to come to fruition. During this time, economic growth may slow because of uncertainty, but we do not expect a recession. So far, leading economic indicators confirm this. However, this period could be difficult, with politically-driven volatility shaping the investment landscape.
The Bank of England has supported growth by cutting interest rates to 0.25% and re-launching its quantitative easing programme. The chancellor is likely to announce further measures to boost the economy in the Autumn Statement on 23 November, including a package of fiscal stimulus.
As we are all aware, Sterling fell sharply in the aftermath of the EU referendum result and has suffered further weakness following the Prime Minister’s party conference speech, after which ‘hard Brexit’ appears more likely. The majority of global investors see significant risks ahead for the UK economy and therefore sterling, and are very negative on the short-term outlook for the currency.
Our research shows that currencies have an equilibrium exchange rate from which they can deviate substantially, and for considerable periods, but to which they gravitate again over the long term. Measured against all major developed market exchange rates, our analysis suggests sterling is substantially undervalued and is likely to appreciate over the next few years.
Along the way, currency markets will remain volatile owing to political uncertainty surrounding Brexit, the US presidential election and elections in Germany and France in 2017. Even if the UK is shut out of the single market, which would affect the equilibrium rate, sterling still appears undervalued.
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