If you ever needed evidence of the ‘herd’ mentality of financial markets, just look at what has happened to the pound recently.

During the past three weeks, sterling has taken an 8% tumble, much of it during the hours since Mervyn King, Governor of the Bank of England, finally used the “R” word in a speech in Leeds. But most commentators have been predicting a major slowdown in the economy for a considerable time and the likelihood of a technical recession (there, I’ve said it now too) for at least two months. So why discount sterling now?

Weakness in the pound could have a rather different root cause – and one that the BBC (which supports this government whenever it can) will be unlikely to report. The bank rescue plan – itself is a necessary evil caused by the inability of the government correctly to regulate the banking sector – should have been relatively easy to pay for. Unfortunately, it is not, because the government has been borrowing far more than it should have done, to cover the cost of over-ambitious spending plans without having to raise tax revenue, throughout more than a decade of economic growth.

The result of lax spending controls and waste is that there is nothing left in the kitty left to allow for ‘spending our way out’ of a recession without borrowing even more. This means that we will all eventually have to pay more in tax.

The problem is that in a recession, the tax-take falls, so governments have even less to spend.

No wonder money markets, already jittery at the prospect of more interest rate cuts to come, are discounting sterling as a potentially safe haven for capital.

How will this affect you?
In some respects, recent events do “not mean that the pound here in Britain, in your pocket … has been devalued” (Harold Wilson 19th November 1967) which is something of a truism. On the other hand it does mean that imports will be more expensive, which is potentially inflationary, and that holidays abroad will be more expensive (this could reduce air travel, which should please the ecologists).

Conversely, it will make our exports more competitive and we have long felt that something is required to give the manufacturing sector a boost; certainly nothing in the past eleven years of ever increasing regulation and bureaucracy has helped industry, especially the SME sector.

As far as investments are concerned, there may be some impact on the price of (and yield from) overseas equities, but in the overall picture remains broadly unaffected.

Investments should be seen in the medium to long term, by which we mean five years plus. Any shorter timescale should be viewed as requiring protection against short term volatility and minimisation of costs. This generally implies deposits, although as most savers are currently finding, deposits are not free of cost. Banks are currently widening their margins between what they pay savers for money and the rate they charge borrowers. Risk is also generally only limited to £50,000 for bank accounts.

It is also worth considering putting as much as possible into tax efficient savings such as ISAs and pensions now, to protect your capital against higher taxation later on.

Planning any aspect of your investments is essential; why not contact Robert Bruce Associates for individual assistance?