In June 2016, sterling fell by around 10% in response to the UK vote to leave the EU. This de facto devaluation gave strong support to UK markets, especially UK property markets. In fact, after the Tory election victory and introduction of legislation enabling a EU Referendum in May 2015, sterling had already begun to fall from its post-GFC highs in June and July 2015. Hence, in early July 2016, after sterling fell by around 10% in response to the UK vote to leave the EU, it was really down by 18% against the dollar and 22% against the euro.
While a substantial decline in sterling might reasonably be expected to rattle confidence in the UK, cross border investors, already familiar with the UK, and confident of its long-term political stability and lasting importance as an international finance hub, could only view UK prime long income assets on offer as offered with a sudden substantial discount, or at the least, a potential future premium when sterling eventually recovers.
Unsurprisingly, cross-border investors have dominated UK commercial property investment since the vote to leave, accounting for almost 50% of all purchases across the UK and 70% of Central London purchases. Likewise, it is no surprise that overseas investment into the UK was dominated by dollar denominated Asian investors (31%) and by US investors (26%). Europe accounted for 20% of total overseas investment.
Sterling has been volatile over the past three years, buffeted by Brexit uncertainty and especially by an uncharacteristic episode of heightened domestic political instability in mid-2019. Despite unresolved Brexit issues, a decisive general election in late-2019 steadied the UK’s polity and a gradual reversion of sterling to its long-term equilibrium level over the next several years was widely forecast and already apparent in January.
The pandemic interrupted this trend and has weakened sterling as a new episode of global economic turbulence was aggravated by unresolved trade negotiations with the EU. An agreement would, no doubt, strip away this uncertainty and sterling would rebound. A collapse of negotiations, a postponement or a ‘hard’ Brexit would, no doubt, delay sterling’s recovery further, but sterling will recover.
Sterling’s international equilibrium level is, of course, subject to debate, as are the methods for its calculation, ranging from complex calculations of relative purchasing power parities (PPP) to what The Economist describes as its ‘Big Mac Index’ (a version of PPP linked to global prices of the Big Mac hamburger).
Looking at sterling’s trade weighted historical long-term market value offers one means of evaluating the potential for a sterling post-trade negotiation appreciation.If sterling’s present trade weighted index value is compared to its 40-year average (October 1980 to October 2020), then the current value is around 10% below this long-term average. Likewise, if the sterling long-term average is based on a time series dating from 1998 (the year that the Bank of England became independent), then sterling is around 12% below its long-term average. Introducing the USD exchange rate complicates this simple pattern, but the USD is a good comparator given its lingering status as the global reserve currency. At its current (October) dollar rate ($1.30), sterling is 18% to 20% below its long-term averages (as above). According to PPP comparators, it may be down by a modest 9% against the dollar, and according to the Big Mac index (July 2020) down by either 11% (adjusted for per capita GDP) or 25% (unadjusted). Oxford Economics forecasts show that sterling is expected to appreciate against most currencies over the next five years. The trade weighted index is forecast to rise by 4.7%, but market value rises of 12.3% against the dollar and 11.5% against the Chinese yuan are also forecast.If anything reasonable can be concluded from this barrage of numbers, it is that sterling is undervalued against global currencies, probably by a double-digit percentage, and that a Brexit deal may result in a double-digit reversion to its long-term equilibrium level certainly over a typical investment horizon of five years. For cross border investors with a non-sterling base, this double-digit appreciation back to long term trend might reasonably be understood as providing either added protection to entry level values, or as a possible premium to future expected returns. In either case, recent trends are promising as currency speculators shift from net short positions against sterling to net neutral positions. Interestingly, since the EU referendum in mid-2016, speculators have held net short positions against sterling 75% of the time. In fact, speculators have been short on sterling 73% of the time since the GFC in 2008. In raw numbers, short positions held against sterling on the Chicago and New York futures exchanges since the UK vote to leave the EU total 8.3 million.
Long positions number 0.9 million. Given that the ‘sterling discount’ since the EU vote has remained relatively stable at around 10%, simple logic suggests that when sterling rebounds, it must rebound strongly over short durations. Alternatively, logic might suggest otherwise that the short positions are generally marginal, which would also imply that long positions must be that much stronger.
In either case, when certainty returns post-Covid-19 and post-Brexit, look for a sharp rise over a what may prove to be a much shorter time frame than many expect.
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About the Author
Chief Economist, and Head of Research of Forecasting at Colliers International, Walter Boettcher has over 20 years UK and European property industry experience. Highly renowned for his publications on Brexit, Economic Outlook & Trends, and Property Cycles, Walter has redefined how research can be used to support agency and professional services business development.
For more information, please email email@example.com.