FTSE 100: 7487.87 ▲ 56.96 (0.77%)
Investors banking on a weak pound continuing to lift portfolios in 2017 could be disappointed, according to Tilney Bestinvest chief investment officer Gareth Lewis, who sees sterling strengthening this year on interest rate rises and an end to quantitative easing.
The pound's 18.4% fall against the dollar following the Brexit vote had a dramatic impact last year, lifting investors' holdings in overseas assets. It also boosted some domestic holdings: part of the FTSE 100's 15% rise since the vote can be attributed to the boost members received to overseas earnings, given members of the index make around three-quarters of their money abroad.
But Lewis predicted that trend would come to an end this year, despite the first few days of 2017 seeing the pound threaten to revisit 31-year lows against the dollar on fears of a 'hard' Brexit.
He predicted the Bank of England would be forced to reverse the stimulus package introduced following the EU referendum, which saw interest rates cut to 0.25% and a six-month, £60 billion government bond-buying revival of 'quantitative easing' (QE) alongside £10 billion of corporate bond purchases.
Lewis said the Bank could reverse the rate cut, adding that more quantitative easing when the current round comes to an end next month was unlikely.
‘We don’t know what Brexit will mean…so setting monetary policy on an unknown outcome is dangerous,’ he said.
Lewis also pointed to an uptick in bank lending last year that proved further monetary stimulus was not needed.
‘There has already been a pick-up in UK bank lending... which has turbo-charged UK monetary expansion, suggesting the UK has a growing inflation problem requiring Bank of England action,’ he said.
‘Language has already changed to reflect the new reality. Therefore we could expect QE to end and possible a reversal of the August rate cut.’
Lewis said the increase in bank lending was important because it centred not on mortgage lending but unsecured loans, such as car loans and credit cards. This shows that the consumer spending boom in the UK which has been keeping the economy afloat is predicated on debt.
However, if this debt-fuelled spending increases inflation too much then the Bank will be forced to raise rates, making debt more expensive for those holding it.
‘If you take the bank lending out, the Bank would look through any increases in inflation and ignore it but the lending is what makes me think the Bank won’t ignore [inflation increases, leading it to] raise rates to stop the economy overheating.’
He added that central banks were ‘terrified’ of loan defaults in the face of rising rates ‘but it’s worse to let the debt go up more and more’.
‘At some point [the amount of debt held] will go wrong and it is better to have a bit of pain now [with a rate rise] rather than a lot of pain later,’ he said.
As rates increase, Lewis said sterling would strengthen ‘not against the dollar but against the euro’.
‘Sterling will not be a weak currency this year,’ he said.
The election of Donald Trump as US president indicates the ‘single biggest change [for the global economy] since the banking crisis’, according to Lewis, as the focus moves from monetary policy to fiscal stimulus.
‘Capital markets became excessively reliant on QE and it has not helped the global economy because it requires stimulus that is fiscal,' he said.
In fact, Lewis said the only people to benefit from monetary policy have been those who already own assets like houses and pensions, and companies that should have failed in the financial crisis who have been kept afloat by cheap lending.
When cheap lending comes to an end, however, those companies will finally feel a delayed pinch.
‘There are lot of companies that will not be able to pay [higher interest on their debt] and the defaults that did not happen in 2008 could happen this year,’ he said.