In the last blog post, I promised I would shed some more detail as to what steps an individual could take to protect oneself from further fluctuations in the value of the British Pound.
At this point, I need to make very clear that I am not providing financial advice of any sort – I am merely trying to provide some educational material to help explain some of the issues and options surrounding the financial implications to individuals resulting from the recent Brexit EU Referendum.
Before we go there, I thought I do a very quick recap of …
Big influences on the British Pound over the last week:
The Pound has continued to fluctuate significantly. Early on in the week, “risk-on” sentiment (explanation of “risk-on” and “risk-off”) reappeared on the market helped by a strong US employment report on the 8th July and increased probability of further Quantitative Easing (QE) in Japan due to strong voting in favor of Prime Minister Shinzo Abe (read here on Reuters for more detail). This was followed by the appointment of Theresa May as the UK’s new Prime Minister in the middle of the week – this removed uncertainty from the market – which generally has a positive impact. Finally, the Bank of England decided to keep interest rate unchanged at 0.5% on Thursday – in contrast a strong anticipation that the key rate would be cut to 0.25%. All this developments assured a great rollercoaster ride. Against the US dollar, the Pound closed the prior week at $1.2940, then declined to as low as $1.2780 (-160 pips), before reaching a high of $1.3480 (+700 pips), and then closing at $1.32 (-280 pips). That’s a rather big range.
What can an individual do to protect oneself from such wild fluctuations?
Alternatives for Protection:
- Do nothing
- Convert British Pound into another currency such as US dollars, Euros or Japanese Yen either as cash or keeping it in a foreign currency denominated bank account – this can be done using a normal UK high-street bank, or a FX brokerage house.
- Using a Contract for Difference, also available from many UK brokerage firms.
- Using a “spreadbet” instrument, available from many UK brokerage firms and/or spreadbetting firms.
- Purchase “option contracts” – these are often referred to as “derivatives” – and are a more complex financial arrangements.
Protecting = reducing range of possible outcomes = risk management
Something to keep in mind – and it’s a point that came out in the conversation between my friend Angela (not Angela Merkel) and I – is that by doing protection one could merely aim to reduce the extreme range of possible outcomes. For example if one were to convert all of one’s savings into US dollars then this would be a great outcome if the Pound continued to depreciate/fall, but it would be bad if the Pound recovered/rose. However if one converts HALF of their money into US dollars, then regardless what happens to the value of the pound – the difference between the worst possible and best possible scenario is reduced. In other words the volatility or risk has been lowered. This is essentially what we are looking for when buying any type of insurance (say home insurance or health insurance). Another way of summarising this type of behavior is to say “we are managing risk”.
I will try to point out some of the pro’s and con’s associated with each alternative, discuss some of the practicalities involved and also point out some companies who provide the various alternatives.