By Alessandro Pasetti, 6 August.
One of the most challenging questions we usually receive from continental European real estate investors looking for solid property deals in the UK is when is the best time to be opportunistic and opt for currency arbitrage, borrowing in euros to invest in Sterling-denominated assets.
Take our promising portfolio of projects in the UK, for example: it is a bet on outstanding yield prospects as well as a rising GBP/EUR exchange rate, which currently hovers around multi-year lows of 1.11.
The euro has appreciated swiftly since Brexit, “but quite frankly, I am not ready yet to bet on the British pound”, is one comment we heard recently, which sums up the mood of several bearish investors in Europe.
However, it is worth considering that the correction of the British pound is not just a reaction to Brexit. It also has a lot to do with monetary policies in the UK as well as in the rest of the Western world since mid-2015, when it became apparent that the Bank of England would not follow the Federal Reserve in hiking interest rates from historical lows.
As a result, the domestic currency has struggled since last summer both against the greenback and the euro, but could that now change?
Recent weakness in the GBP/EUR is understandable: the outcome of Brexit weighs on the exchange rate, and investors looking to bottom-fish for a bargain would do well to keep a close eye on British assets, and not just properties.
The charts below are self-explanatory when it comes to gauging downside risk from these levels…
(Source: Yahoo Finance UK)
(Source: Yahoo Finance UK)
… testifying to the opportunity of investing in GBP-denominated assets.
This is a very simple approach, but if the British pound reverts to mean based on one-year trends, capital appreciation for those long the GBP/EUR exchange rate would be over 3%; and given its five-year trajectory, it could be almost 15% from these levels.
Remarkably, the latest downgrade by the International Monetary Fund — which at the end of July lowered its GDP growth forecast for the UK from 2% to 1.7% based on “weaker-than-expected activity” — had no impact at all on the exchange rate in the immediate aftermath of the announcement, which means the currency is mainly influenced by political and inflation risks these days, rather than shaky fundamentals.
Source: Trading Economics
Bulls & Bears
Equally important as understanding why the British pound is so low is acknowledging that there is no consensus around its future performance — analysts and economists are divided between bulls who argue the slump is almost over, while the bears insist GBP/EUR parity is on its way.
It would seem that the one certainty is further confusion with headlines such as “super-Thursday key to trade against the euro and US dollar”, reflecting how divided opinion is amongst analysts and traders.
While sentiment is likely to determine volatile currency trades through to 2018 and beyond, household indebtedness in the UK combined with the inflationary forces that have harmed confidence justify risk taking on the British pound, in my view, although the gap between growth in wages and property prices remains one variable to watch.
Of course, currency risk is just one side of the coin for those looking to invest in the British real estate market — many investors are also worried about tax hikes and the risk posed by little capital appreciation over the medium term, which will be discussed in a follow-up column, although it is worth considering that more aggressive monetary policies could surprise the bears as early as next year, particularly if core inflation remains under control and “hard Brexit” fears fade away.
(This post was written by Alessandro Pasetti. Ale is the founder of Hedging Beta Ltd. He writes about investment strategy and assets valuation for European clients as well as Seeking Alpha. Based in London, he previously worked for about five years at Dow Jones/The Wall Street Journal, producing analysis for the IB community. Prior to that, he contributed to the launch of London-based Loan Radar, where he worked for three years. He had stints in equity research at Bear Stearns in London, HVB in Munich, and Unicredit in Milan.
It was edited by Gavin van Marle, managing editor of London-based The Loadstar. Gavin is also the author of the book Around the World in Freighty Ways: Adventures in Globalisation. He has won numerous awards, including the Seahorse Journalist of the Year 2011 and 2009, and Supply Chain Journalist of the Year 2010 and 2014. )