Why U.K. Stocks Are Soaring Even Though the Pound Just Hit a 31-Year Low
The British pound dropped to its lowest level since 1985 on fears that the U.K. is rushing into a divorce settlement with the EU that will cause irreparable damage to its economy.
Sterling also hit a five-year low against the euro, as a string of comments coming out of the annual conference of the ruling Conservative Party suggested that policy-makers were playing down the risks of a so-called “Hard Brexit” both to U.K. manufacturers and to its all-important financial sector.
This weekend, Prime Minister Theresa May had said that she intended to prioritize control of immigration over full access to the EU’s Single Market. That threatens to be more disruptive to Britain’s trade with the EU than some of the ‘Brexit Lite’ options that were theoretically on the table. The EU is the destination for over 43% of the U.K.’s exports.
At the same time, May had said she would start formal exit talks by March next year, which means the two sides will have scarcely two and half years to work out how their bilateral trade will function on the day after the U.K. leaves. Many analysts think that puts far more pressure on the U.K. than on the EU, given that the U.K. only accounts for a much smaller proportion of EU exports and GDP. The pound also hit a five-year low against the euro, which doesn’t even have the support of a prospective interest rate hike from the Federal Reserve.
The political mood music wasn’t improved Monday by comments from Treasury chief Phillip Hammond warning of a “roller coaster ride” as the country enters what is necessarily a confrontational negotiation process.
The City of London was in a particularly poor mood after a report by Bloomberg citing unidentified government members as saying that the financial services sector would get no “special favors” as the government negotiates the separation settlement. The City, which contributes over 10% of U.K. GDP by most estimates and which fears losing up to 100,000 jobs because of Brexit, has been used to having the ear of government since the days of Margaret Thatcher. It has profited enormously from being the EU’s financial center. It voted heavily in favor of remaining in the bloc, and is struggling to accept the verdict delivered by the rest of the country on June 23 (which was in many ways a vote of protest at a widening income gap vis-à-vis London).
Despite all that, the U.K. stock market continued to generate an illusion of prosperity Tuesday, with the benchmark FTSE 100 index hitting 7,000 for the first time in a year. That, however, is due largely to the fact that the index is dominated by resources giants such as oil companies BP Plc bpaqf and Royal Dutch Shell Plc rds-a or miners like Rio Tinto rio or other global companies that derive most of their income in other currencies, such as HSBC plc hsbc and SAB Miller sbmry.
The broader FTSE 250 index, which is arguably a better gauge of purely British companies, has meanwhile hit an all-time high Tuesday morning—albeit it’s still below its level just before the June 23rd referendum, if you translate that into dollars.