Why the pound is outperforming its rivals and what it means for YOUR holidays, cash and shares

Stock markets have been plunging and the new Labour chancellor has been painting a dire picture of the economy.

But if the strength of a currency is a measure of a country’s financial fortunes, then the UK is going gang-busters.

Sterling is the best-performing currency among the world’s ten major economies this year – after being the second-best last year.

This might come as a surprise to anyone who has been listening to Chancellor Rachel Reeves, who takes every opportunity to talk down Labour’s economic inheritance as the worst since the Second World War.

Her doom-laden view is not one shared by Bank of England governor Andrew Bailey – or by the currency markets for that matter.

Mr Bailey told the Mail on Sunday that the fact inflation has fallen to the Bank’s 2pc target was ‘good news’ and a reason to be optimistic’ after using his casting vote to push through the first interest rate cut in four years.

His upbeat verdict is shared by hard-nosed foreign exchange traders.

They handle trillions of pounds every day on behalf of international investment banks and their clients, much of it through dealing desks based in the City of London.

Since the Liz Truss debacle, the pound has staged a remarkable recovery.

Against the dollar – still the world’s de facto reserve currency – it has recovered from a record low of $1.06 in the aftermath of the disastrous mini-budget two years ago, to stand at almost $1.28 today.

At €1.16 the pound is also up a few cents on the euro so far this year.

This is good news for the millions of Britons sunning themselves on foreign shores.

Their hard-earned pound now goes that bit further. That holiday hacienda is that bit cheaper, the taverna tab slightly less wallet-lightening.

But can investors, as well as sun-seekers, profit from the pound’s newfound popularity?

It used to be said that nobody became poor betting against sterling.

Its post-war history against many major currencies has been one of gradual decline, punctuated by periodic steep falls and limited recovery. How strong Britain’s currency is relative to those of other major nations’ matters.

Too strong and it risks strangling exports as goods and services sold overseas become more expensive when converted into local currencies.

Too weak and imports become more expensive, fuelling inflation and leaving UK companies that are priced in pounds cheaper and therefore more vulnerable to foreign takeover.

On balance a stronger currency is better than a weaker one – and not just because it means your holiday cash will go further abroad.

It can also be a source of national pride.

When the pound was unceremoniously hounded out of the European Exchange Rate Mechanism (ERM) – forerunner to the euro – Germany’s best-selling tabloid, Bild, splashed with the following headline: ‘You lovely, strong deutschmark, make our lives cheaper!’

But the 1992 devaluation of the pound against the German currency turned out to be a blessing in disguise for the UK. It marked the start of an export-led recovery that helped haul Britain out of recession. Goods and services priced in pounds were suddenly cheaper, encouraging foreign firms to buy British.

The episode also served as a forewarning of how a single currency can wreak havoc with an economy. Ruinously high interest rates of up to 15pc had been introduced in a doomed bid to defend sterling and stay in the ERM.

But sudden, competitive devaluations can also cause lasting damage.

In 1967 – when governments could still manipulate exchange rates, something they can no longer do in today’s modern markets – Labour lowered the value of the pound from $2.80 to $2.40, a drop of 14pc.

The quick fix was designed to revive a flagging economy by boosting exports.

Prime Minister Harold Wilson famously sought to play down the significance of the move, saying it ‘did not mean of course that the pound here in Britain, in your pocket, or purse or in your bank has been devalued’.

But it left the economy horribly exposed to imports priced in stronger dollars – notably oil – which sky-rocketed in early 1970s, fuelling runaway inflation, power blackouts and a three-day week.

Experts point out the pound has recovered, but may still lack fundamental strength.

‘It may be the best performing G10 currency in the year to date but I would not call it a strong currency,’ says Jane Foley, head of foreign exchange strategy at investment bank Rabobank.

‘I would describe it as a currency getting back on its feet after a period packed with crises, weak growth and a fair amount of political chaos and uncertainty,’ she adds.

Ironically, some of the credit for sterling’s revival can be laid at the door of Rachel Reeves. Currency analysts like Foley are giving her – for now – the benefit of the doubt.

‘So far she doing a good job in talking up her image as someone who can be trusted with the purse strings,’ says Foley.

This – and the prospect of tax hikes in her Autumn Budget – augurs well for other UK assets such as government bonds known as gilts, she adds.

They have risen further since Labour won last month’s election, meaning the cost of servicing the national debt has dropped, helped by faster-than-expected economic growth, which lifts tax revenues.

This rosier outlook for the UK economy has prompted some experts to raise their forecasts for sterling.

‘The UK has been something of a pariah in recent years (but) appears to be more stable now and that is in contrast with Continental Europe, especially France,’ says Philip Shaw, UK chief economist at investment bank Investec.

‘If the government is anywhere near successful in delivering higher growth, improved sentiment towards UK plc could benefit various British asset classes, including equities,’ he adds.

Investec has upgraded its view and now expects the pound to rally to $1.32 by the end of this year, and $1.35 by the end of 2025.

Even Bank of England governor Mr Bailey sounds positive about the pound’s performance.

Asked by the Mail on Sunday if he was encouraged by sterling’s recent strength, he said: ‘Recent movements in sterling will make imported goods and services a little bit less expensive. I’m sure many will welcome that after the strain on household finances of the past few years.’

But he warned that exchange rates ‘can move around from month to month and week to week’.

‘What’s most important for us is the impact of any moves in sterling on inflation, and we take that into account when we set interest rates,’ he added.

What does it mean for my investments?

At first sight it may seem the FTSE 100 index of leading London-listed shares is a good bet but a stronger pound is ‘a double-edged sword’, says Richard Miles of fund manager Fidelity.

A number of the largest companies in the FTSE 100 including oil giants BP and Shell receive their earnings denominated in dollars.

‘Each dollar BP earns will buy fewer pounds if sterling has appreciated,’ Miles adds.

That translates into lower dividends from these companies in sterling terms but lower share prices too.

‘This is why the FTSE 100, after a brief moment of shock, actually rose after the unexpected result of the Brexit referendum,’ Mr Miles recalls.

‘The pound had immediately sunk significantly and investors soon realised that this was actually good news for the overseas earnings of the international companies that dominate London’s blue chip index.’

Russ Mould of investment platform AJ Bell, says currencies are only one factor in deciding what shares to buy.

‘Taking a view on an asset class – bond market, stock market – or company shares on the basis of a view on the currency is probably a quick way to the poor-house.’

‘There are just too many variables – macroeconomic and geopolitical, global and domestic – for anyone to first to get the currency right and then work out how that could benefit a specific company.

‘Forget it,’ Mr Mould warns.

A smarter way – for the brave – might be to buy US technology stocks.

‘They’ve just got a lot cheaper,’ says Fidelity’s Mr Miles.

‘The strengthening of the pound over the past three months has combined with the recent US tech sell-off to create what could be a buying opportunity for British investors,’ he adds.

That’s because when sterling rises against the greenback, each pound buys more of the dollars needed to invest in US shares.

‘So your money goes further even before we consider the steep falls in some American tech stars over the past few weeks,’ says Mr Miles.

Take microchip designer Nvidia, which in June briefly became the world’s biggest company quoted on a stock exchange.

It has fallen by 20.8 pc since, while the pound firmed from $1.27 to $1.29.

That means in sterling terms one Nvidia share cost 107p at its peak, but is now worth just 83p – or a larger fall of 22.4 pc.

Nobody is saying investment decisions should be made on currency considerations alone, but they shouldn’t be ignored either.

‘Investors can help themselves if they always bear currency exchange rates in mind when they invest in overseas assets – and even when they buy or sell some British-based investments,’ Mr Miles concludes.