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British political discussion since June 23rd has been dominated by the effect Brexit will have on the economy, and Tuesday’s stock market reaction has given us reason to be very fearful.
 
The exchange rate of the pound against the dollar dropped from just over $1.23 per £1 at 13:15 UTC on Tuesday, to hovering just above $1.21 per £1 between 17:10 and 21:40.

value-of-pound-against-dollar-2016-weekTuesday’s headlines did include figures on the amount of tax revenue expected to be lost when the UK does exit the EU. While the £66 billion figure made a lot of headlines, it won’t have been newsworthy to the majority of professional investors – as Duncan Weldon, Head of Research at the Resolution Group investment firm has pointed out, this was a rehash of the pre-vote Treasury report, and as a result “shouldn’t move currency that much”.

Tuesday’s fall follows a similar ‘flash crash’ on October 6th and 7th. But that was, according to IG Markets’ analyst Angus Nicholson, likely to have been “an algorithm-driven flash crash” as low levels of trading in the Asian market “would have forced other algorithms to join in and magnify the fall”. There seems to be no such explanation for Tuesday’s fall.

But are there reasons to be optimistic about the British economy? After all, by the start of October the FTSE100 was up 11% against it’s position at the start of the year.

Unfortunately, the FTSE Local UK, made up of companies who make more than 70% of their revenue in the UK, is down 9% in £ terms and 20% in dollar terms.

The most logical conclusion from those two apparently contradictory analyses of British companies would seem to be that, to quote Duncan Weldon, “a collection of multinationals with non-Sterling revenues” are performing well, but this strong performance won’t necessarily be good news for the economy as a whole. In fact, it may well be that the dropping value of the pound is encouraging investors who want to invest in multinationals to do so in London rather than in New York or Tokyo, to get more bang for their…quid.

The pound has already recovered somewhat from Tuesday’s low. On Wednesday it was bouncing around at roughly middle-distance between Tuesday’s high and low points. Seeing this as an uncomplicated positive would be to ignore the way trading works. Whenever a currency or company hits a low point, there’ll be an upsurge in investment, as buyers look to grab a bargain. Last month’s Samsung Galaxy Note 7 recalls saw the company’s drop dip, before bouncing back. It even hit an all-time high on October 7th, days before plunging again following a second round of recalls. The uncertainty over exactly when and how Britain will leave the EU is likely to result in several relatively positive days like Wednesday, but more than likely as part of an overall downward trend.
When reacting to the flash crash of October 7th, Yosuke Hosokawa of Sumitomo Mitsui Trust Bank announced that:
“We thought today’s plunge was a matter of time. Negative factors were mounting against the pound, and eventually the dam broke. We have not seen the bottom yet.”
Maybe there’s a legion of investors just biding their time, certain that they’ll sell their shares in British companies but looking to make short and medium-term profits before things take a downturn. If Tuesday’s reaction was a result of investors with their hands on the ‘sell’ button getting itchy fingers, then an even more dramatic downturn in both the value of the pound and companies with predominantly British revenue is likely to be around the corner.

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