Will the pound’s weakness continue to drive the FTSE 100?

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The relationship between the weak pound and a strong stock market is showing signs of fraying, analysts pointed out today, as the FTSE 100 dives even as the pound remains under pressure.

Sterling has been through the ringer this week, swinging up and down on the slightest whisper of Brexit news, although today's trading has been slightly calmer, with the currency settling at $1.22 against the dollar and €1.1060 against the single currency.

Since the majority of earnings for FTSE 100 companies come from overseas, and the bluechip index also collects a fair share of attention from international investors, stocks have moved higher in sterling-terms since the EU referendum kick-started an 18 per cent slide in the pound. The FTSE 100 flew to a record intraday high of 7,129 earlier this week.

In 11 of the last 14 trading sessions sterling and the stock market have moved in opposite directions.

However, this relationship could be breaking down as attention turns to how well London-listed firms are likely to perform in the midst of testing negotiations between the UK and the EU over Brexit.

Despite the pound stabilising today, the FTSE 100 is down 1.2 per cent at 6,941.

Societe Generale's Kit Juckes suggested the Unilever-Tesco Marmite price war could be a sign that the falling pound is going to squeeze UK-facing firms as they struggle to deal with how much of the extra cost to pass on to consumers. Meanwhile, higher prices are set to sap purchasing power, IHS Markit's Howard Archer said today. 

Juckes said: "The link between a falling pound and a rallying equity market may get tested.

"Sterling has fallen as much as can be justified by the move in [interest] rate expectations so far and indeed, by as much as can be justified by the hit to the economy if a consensus view of very weak growth but no recession is correct. But the current situation is anything but stable and another slide would feed concern far more than it would help the UK's competitive position."

As the hitherto predictable relationship between the FTSE 100 and sterling breaks down, Joshua Mahony of Spreadbetters IG also warned volatility could spike as traders struggle to assess the situation.

"The inverse relationship between the FTSE 100 and sterling has seemingly taken a breather this week. The positive effect of a weak pound upon stocks for companies earning abroad still holds, yet perhaps the focus is instead moving onto different concerns," he told City PM.

"There is certainly a feeling that the benefits of a weak pound have largely been factored into the FTSE 100 of late. It is not to say that the devaluation of the pound is likely to drive the index lower, yet the reasons why a weak pound might drive the FTSE 100 higher appear to be less influential, thus opening the market to wider market effects."

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