Pound / Euro Recovers as FTSE Outperforms

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Pound Sterling has been caught up in the churn created by a global market sell-off, but the relative outperformance of the FTSE and expectations for a Bank of England rate hike next week are providing support.

The Pound to Euro exchange rate has recovered from a sharp fall suffered on Monday and is back in the mid 1.19s again, with the barrier at 1.20 likely to be tested.

Falls in the exchange rate suffered on Monday came amidst global equity market turmoil that created the chaotic conditions that sees foreign exchange markets default into a binary 'Risk-on / Risk-off' reaction.

The Pound tends to underperform the Euro under such conditions.

While U.S. stock markets fell further on Tuesday there was a distinct outperformance being displayed by the FTSE 100, signalling solid international demand for UK assets.

The FTSE 100 has outperformed its major global peers and has fallen just 0.206% in January, whereas the NASDAQ 100 is down 14%, the S&P 500 is down 10% and the German DAX 30 is down 6.0%

"The FTSE 100 has managed to hold on to most of yesterday’s rebound. Signs of a recovery in metals and oil have boosted the relevant sectors in the index, while higher yields have done their bit to lift bank stocks once again," says Chris Beauchamp, chief market analyst at IG.

Above: The FTSE 100 (orange) has outperformed Germany's Dax (dark blue), the S&P 500 (light blue) and the NASDAQ 100 (yellow) in 2022.

Should demand for UK equities continue the British Pound might find itself further supported going forward.

Investors are now fully positioned for another rate hike at the Bank of England next week which continues to provide Sterling support from the interest rate channel.

"Sterling appreciated against EUR as well as against USD over the past weeks. Of course, attention is focussing mainly on monetary policy and the Bank of England’s surprise rate hike in December which provided support for Sterling," says You-Na Park-Heger, an analyst at Commerzbank.

In fact, the key to understanding both Pound Sterling and FTSE 100 outperformance lies precisely with expectations for a higher interest rate world.

"Rising real yields benefit FTSE 100, which is one of cheapest global indices by some distance," says Graham Secker, Equity Analyst at Morgan Stanley.

The UK market has high exposure to energy, 'defensives' and a banking sector which tends to outperform in an environment where rates are rising.

"The UK index also offers good offence in an environment of higher real yields, with the UK's relative price performance closely tracking real yields over time," says Secker.

• Reference rates at publication:
  GBP to EUR: 1.1954
• High street bank rates (indicative): 1.1636 - 1.1719
• Payment specialist rates (indicative: 1.1846 - 1.1894
• Find out more about specialist rates and service, here
• Set up an exchange rate alert, here

Secker says the UK market outperformance is "driven by the strong value characteristics of the index, given significant exposure to the likes of commodities and financials."

Since 2020 global stock markets have surged higher - lead by so-called growth stocks - in a period characterised by generous financial support that came flowing from the world's central banks and governments.

It was the U.S. market that outperformed in this period, thanks not only to Fed policy but by the generous stimulus offered by the government.

The Dollar in turn benefited as international capital flowed into U.S. markets to take advantage of this outperformance.

UK stocks meanwhile found themselves unloved and the FTSE 100 enters 2022 at a discount relative to its peers.

"UK is one of the cheapest major global stock markets," says Secker. "At 12.6x, the FTSE100 is the cheapest major index versus its own 10-year history."

What was once the proverbial ugly duckling could be about to shine.

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