If you were heading off to Europe a year ago on holiday, you would have been offered, as a tourist, an exchange rate of around €1.115 for each pound. This year the rate as at the end of July was about €1.235, an increase of nearly 11%. Eurozone annual inflation is running at just 0.5%, so you are gaining more than 10% in purchasing power. It is a similar story if your destination is the USA, where last year’s $1.48 to the pound is now around $1.655.
The robust performance of the pound is quite a recent event and needs to be set against the sharp fall which the Bank of England allowed to happen during the financial crisis, as the graph below brutally demonstrates.
The recovery of sterling may now be making holidays less costly, but it is having a less pleasant impact on investors:
- UK companies are facing tougher competition abroad for their exports and, at home, more pricing pressure from imports.
- The profits those companies make overseas – whether as exports or in foreign subsidiaries – are being lost in translation. Last year’s $1m was worth about £660,000, but now it is just over £590,000.
- Dividends are being hit. Partly this is because of the profits impact, but it is also because many of the UK’s largest companies use the dollar as a base for their accounting and dividend payments rather than sterling. For example, HSBC paid 10 cent interim in July 2013 and July 2014. For UK investors, the sterling dividend fell from 6.58p to 5.88p.
While the multinationals are suffering, smaller UK companies with a focus on consumer services are doing well, thanks to the recovering economy and much less foreign competition. Managers of UK equity income funds are therefore having to look beyond the big FTSE 100 names if they want to increase the dividend payments to their investors.