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The FTSE 100 Level Is Inverse To The Pound’s Exchange Rate

Trade the FTSE 100 Your Capital Is At Risk
Updated 14 Dec 2021

The FTSE 100 (the Financial Times/ Stock Exchange 100 largest companies) Index is often taken to be an indicator of the health of Britain PLC. This is nonsense, the FTSE 100 is an index of the largest companies listed in London, not the largest companies operating in Britain. In this is the reason why the FTSE 100 index, absent other causes, trades inversely to the pound sterling exchange rate.

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The secret is that companies that are listed in London are eligible to be in the FTSE 100. This doesn’t mean that they have most of their operations in the UK. Some do, of course, Admiral Insurance (LON: ADM) is almost entirely UK based. Other companies have some operations here, say, HSBC (LON: HSBA), and others have absolutely none at all (Antofagasta (LON: ANTO) which is copper mines in Chile).

So, some FTSE 100 companies do depend for their livelihood on the UK market. Others are producing and selling in other places entirely;y. Some produce in one currency and then sell at global prices in another (Polymetal (LON: POLY) is a gold producer with no UK exposure).

The connection is that they are listed in London. It is therefore an error to think that the FTSE 100 is a reflection of the UK economy. It doesn’t move, and therefore can’t be traded, as if it is.   

Now of course there is some influence. Those constituent companies that are part of the index which do have significant operations in Britain will influence the level of the FTSE 100 index. But the majority of the economic activity being measured isn’t happening in the UK. In fact, some 75% of the revenues to FTSE 100 constituents come from outside Britain. They’re also not in sterling those revenues.

The effect of this can be odd. So, yes, how Britain’s economy is doing has an influence. How the global economy is doing has more of one. Simply because the majority of revenues come from out there, not right here. So, things like interest rates, inflation, GDP growth and so on in the UK have some influence upon the level of the FTSE 100. 

However, in the short term, the influence of those can be the inverse of what we might usually expect. For example, rising interest rates will normally mean the sterling FX rate rises. This will push the FTSE 100 down. Because of those 75% revenues that are not in sterling. They’re worth less in £ when the £ rises. The revenues are being made in not-sterling, so they’re less in sterling with a higher sterling exchange rate. 

This mattered a lot around the time of the Brexit vote, The pound was up and down and so was the FTSE 100. But the movements were the inverse of each other, £ up, FTSE down and vice versa.

This will matter in the future too. If the UK looks to be recovering faster than the global economy then the bet will likely be that UK interest rates will rise sooner than elsewhere. The £ will rise against other currencies which could push the FTSE 100 down. At a time when the UK economy is recovering faster.

The effect is smaller in the next index down in size, the FTSE 250, where some 50% of revenues are non-sterling.

It’s an important point to consider about trying to trade the FTSE 100. It can, because of this FX effect, often enough move in the opposite direction to the general conditions in the UK economy.