A sterling story that may spring surprises

Let me be clear from the outset. Within no more than six months the pound will, in my estimation, be valued markedly differently from where it is at present, writes Savvas Savouri, partner and chief economist at Toscafund Asset Management. This means, of course, that from the perspective of buyers from overseas, prices will be very different for all assets on the shelves in “Poundland”, most notably its real estate. While I expect many readers will agree with this assessment, I would be surprised if more than a handful also agreed that sterling will be more expensive. I say this because, as matters stand, the narrative is that the UK economy will be scuppered in its efforts to navigate a course out of the EU. How could any deal possibly be reached that satisfies so many seemingly intractable groups – or, to continue with the maritime metaphor, how can a deal be reached that is not sunk in some way? Rocks and currents There is, after all, the matter of not hitting the 27 rocks representing the UK’s soon-to-be-former EU partners. Even if the UK managed to navigate around them, there are those currents swirling around the EU’s institutions and technocracies. There is also the fact that the crew on board HMS UK is ridden with divisions – between and within Conservative and Labour ranks. To complicate matters, the route out has also to get through the extremely narrow straits representing the party providing the Conservatives with the confidence and supply to govern in Westminster, the DUP. Were all this not enough, the UK’s passage out of the EU has to deal with the pirate ship flying the flag of the SNP. It is precisely because there is such a sinking feeling that the pound finds itself where it does. Indeed, many will claim that when the suspicion that the UK economy’s attempted escape from the EU will scupper the ship becomes a reality, then the pound will sink with it. As things stand, then, escape is possible but not thought likely, so the “market” is pricing in contingent probabilities for the pound. Let us suppose that a “deal” level for the pound against the euro is circa 1.3, whereas a “no deal” rate is parity. Then, with the current value of circa 1.10, the implied risk-free probability of a good deal is one-third (since market participants are risk-averse, the implied probability is actually higher but still way from 100%). The point I would make is that as and when ‘’the market” recognises that a deal will happen, so sterling will strengthen towards whatever level captures such an outcome. For my part, circa 1.30 is a rather conservative estimate for where a Brexit-relief-rally will take sterling against the euro. And just as it does against the euro, the pound sits on a risk curve relative to the dollar. The latter is a curve that is steep enough to see the pound move towards circa 1.60 in short order once it becomes clear the passage out of the EU has been successfully navigated. Another reason I am confident the pound is undervalued against the dollar is my belief that the expectation as to the FOMC’s “policy path” perfectly prices the dollar. What I mean here is that even the most marginal disappointment in meeting rate rise expectations carries a risk to the dollar. To make the dollar’s future all the more worrying, I am confident its recent strength disguises some profound problems –some long-standing, others brought on since Trump assumed office. Overseas impact All in all, we find ourselves at a point where within a relatively short space of time the pound – and all assets within it – will become around 20% more expensive for those buying in from overseas. However much we are told the UK’s economic future will depend on the nature of its EU exit, the reality is that its engagement with China, India and other emerging behemoths, will play a far greater role. And all the indications are that nowhere across Europe will enjoy the benefits of emerging market growth more than the UK. While part of the UK’s ever-increasing economic engagement with the likes of China will be through selling places at our universities and private schools, education is but one of a great many symbiotic avenues. The UK will quite simply become China’s most important hub in the western hemisphere – regardless of our Brexit terms. And in investing in the UK, China will buy existing real estate as well as building entirely from scratch, and will do so widely across the country. As the pound strengthens following a seamless exit from the EU, so China’s past investments in the UK will prove all the more rewarding. If, however, the pound were to fall further in the event of no deal, be in no doubt that China will capitalise on the improved affordability of all the real estate there is for sale in Poundland.