If ever there was an example of the “law of unintended consequences”, it was chancellor Kwasi Kwarteng’s mini-Budget with its sweeping tax cuts. While its aim was to stimulate economic growth, concerns about how the government would pay for the cuts spooked the markets.
In the wake of the chancellor announcing his economic plan, the pound dropped to around $1.03, the lowest level since decimalisation in 1971. While it then recovered to its previous level of around $1.13, research by Reuters makes for sobering reading, as it suggests some analysts predict sterling will drop again before the end of 2022.
Of those analysts questioned by Reuters, more than a quarter said that they believed there could be parity between the pound and the dollar, meaning £1 would be worth $1. If this happens it could create further uncertainty for Britain’s economy and could have implications for your finances.
Read on to discover four ways a fall in the pound could affect your wealth.
1. Your weekly shop could go up
A weaker pound is likely to mean that the cost of raw materials or goods imported into the UK will rise, which could mean the price you then pay goes up too. According to the Guardian a fall in the pound’s value could result in fuel prices going up at the pumps, and electrical goods such as iPhones becoming more expensive.
Worse still, as Britain imports more than 50% of what it eats, the price of many food items could go up, meaning the amount you spend on your weekly shop is likely to increase. When you consider the Guardian reported that UK food prices soared by 10.6% in September because of the war in Ukraine, the idea of further rises will hardly be welcome.
2. The cost of borrowing will increase
If the pound drops in value it’s likely to result in interest rates rising further. The reason for this is that the rising cost of goods is likely to push inflation up, meaning the Bank of England (BoE) could increase interest rates to bring it back under control.
This might be unwelcome news for many borrowers, and in particular, those with variable rate mortgages, which tend to following the movement of the BoE’s interest rate.
If you have a fixed-rate or discount mortgage that’s coming to an end, you could see your repayments increase if you’re moved onto an SVR mortgage. Speaking to your lender to discuss whether they would be prepared to offer a fixed-rate deal may help shield you from a significant increase in your mortgage repayments.
3. But, interest rates on cash savings are still not keeping pace with inflation
While higher interest rates might be good news for savers, care needs to be taken, as holding too much money in cash could reduce its value in real terms. To demonstrate this, consider the following.
According to the Office for National Statistics, inflation stood at 10.1% in September 2022 Yet on Tuesday 11 October 2022, Moneyfacts showed that the top easy access savings account paid just 2.10%, and the best five year fixed-rate only offered 4.57%.
As these are significantly below the rate of inflation, any money being held within them will not keep pace with the rising cost of living, meaning the cash will drop in value in real terms.
One way you might be able to inflation-proof your money is to consider investing it, as the stock market typically provides greater growth potential. Research by Schroders found that between the start of 1952 and end of May 2022, UK equities returned 11.7% a year on average, compared to cash, which returned an average of 6% a year.
Please remember that past performance is no guarantee of future performance.
4. The stock market could become more volatile
As a fall in the pound could reduce company profits and increase uncertainty for businesses, the stock market could become even more volatile and experience a downturn. While short-term downturns should always be expected when investing, it’s important to stay calm and focus on your long-term objectives when they happen.
Making a knee-jerk decision to sell your stocks in an attempt to limit losses could be something you later regret, as it may deprive your money of any chance to recover when the markets bounce back.
The following illustration shows the performance of the FTSE 100 between September 2002 and September 2022. The index tracks the top 100 companies registered with the London Stock Exchange.
Source: London Stock Exchange
As you can see, during the period there were several downturns. If you had of sold your shares during these downturns, your money would have missed out on the subsequent growth when the index bounced back.
That’s why working with a financial planner can help you understand what’s happening with your investments, and what your best option might be.
Get in touch
A drop in the value of sterling could have implications for your money and investments. That said, whether these have a negative effect on your long-term wealth often depends on how you react to them.
Speaking to a financial planner could help ensure you understand your options and make a decision you don’t regret later on. If you would like to discuss how a drop in the pound’s value could affect your wealth, or would like to discuss investing or your pensions more generally, please contact us on firstname.lastname@example.org or call 01234 713131.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.