By most well-informed reckonings, the latest rise in the FTSE 100 has been almost entirely driven by a corresponding fall in the pound as markets fret over the implications of the UK exit from the European Union.
A weaker pound, as pointed out by former Bank of England governor Mervyn King, can be beneficial to UK business and even the economy as a whole, up to a point. The clearest manifestation of this is in the artificial boost it gives to companies’ earnings when revenues drawn from outside the UK are converted into pounds.
There are major concerns however around the pound being too weak for too long, as it can feed through into higher costs of living and dent the consumer confidence that is so vital to an economy.
If the recent rally is in fact built on the sand of a falling pound and political headlines alone, the index could soon be back well into the mid six thousands. At some point equities prices have to restore their link to the real performance of companies.
If the pound stages some level of recovery as news headlines become more benign and inflation starts to comes through as oil prices also climb, interest rate rises could be back on the cards sooner than is currently priced in.
It is also worth keeping in mind that last time the FTSE 100 topped 7000, it was relatively short-lived. The index crossed the milestone in April 2015, but was back well under it within a month, and kept on sliding for a couple of months more.
The situation is very different now than it was last year, but it cannot be entirely discounted that the symbolic milestone of 7000 is seen as something akin to a short term ceiling by many investors.
“The markets are currently heavily influenced by all things political and have been since the early summer,” noted Rowan Dartington Signature’s Guy Stephens. “This is making valuations increasingly difficult to assess as distortions abound involving currencies, elections, interest rates and quantitative easing. These are all macro-economic measures which are pushing markets around causing investors confusion.”
