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Foreign exchange, also sometimes called FOREX or FX, is a crucial part of the lifeblood of the global economy – keeping commerce, travel and trade moving. On a personal level, moreover, foreign exchange can have a big impact on an individual’s wealth and finances.
This is especially true for British expats living in Spain and other foreign countries, which often involves regularly changing currencies (e.g. pound sterling to euros). Yet foreign exchange can also have “hidden” effects on your financial plan which are important to be aware of.
Below, our Murcia financial planners here at Scottsdale explain how forex works in 2023, including some thoughts on how British expats can navigate it more confidently. We hope this content is helpful. If you want to discuss your financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
+34 966 460 407
What is foreign exchange?
At its simplest level, foreign exchange is about converting one currency into another. Many travellers are familiar with this. Before coming to Spain on holiday, for instance, a British tourist may go to their local Post Office and change pound sterling (GBP) to euros.
The amount of euros you get for GBP, however, is not set in stone. The exchange rate changes regularly based on supply and demand. If fewer people want GBP, then more people sell the currency – driving down its value relative to another, more popular one (which subsequently becomes more “expensive” to buy with GBP).
A range of factors affect exchange rates, however. For instance, if a central bank in a given country raises its interest rate, then lenders in that country can generate higher returns compared to those in other countries where a lower rate prevails. These higher returns can attract foreign investors and drive up demand for that currency – raising its value.
In the UK, its central bank (the Bank of England, or BoE) has raised interest rates to their highest level in 15 years, currently standing at 5.25%. This is a full 1% above the Eurozone and just below the US.
The attractiveness of GBP to foreign investors has been hampered, however, by the country’s high inflation rate. It stood at 6.7% in the year to August 2023 compared to 5.9% for the same period in the Eurozone. Normally, a country with lower inflation experiences higher spending power relative to other countries, pushing up the value of its currency.
How does FX affect me as an expat?
If you are a British expat living in Spain and your income and expenses are largely handled in euros, then exchange rates likely have a low impact on your daily finances. One area where they may impact you is during the purchase of imported goods.
For instance, UK-produced food items which are shipped to Spanish supermarkets. If the euro falls relative to GBP, then this change in exchange rates could make such items more expensive. If it rises, then vice versa.
However, if you receive a UK-based income whilst living in Spain as a British expat (e.g. from your State Pension), and your expenses are primarily dealt with in euros, then exchange rates will have a more noticeable impact.
A devaluation in GBP, for instance, means that your “spending power” in Spain would be eroded. If GBP rises relative to the euro, however, then GBP will stretch further – making you better off in real terms.
How do I navigate foreign exchange?
If you receive a significant portion of your income from the UK whilst living in Spain (or you plan to do so), then it is worth “stress testing” your monthly budget to ensure that it can cope with potential changes in exchange rates between GBP and the euro.
For instance, if GBP falls by 10% (meaning you can buy fewer Euros with your income), would you still be able to afford your outgoings? If exchange rates move in the other direction, however, then you could save or invest the surplus euros.
Moreover, forex is also important when building an investment strategy. Exchange rates can have a big impact on your returns, and this is often unnoticed by investors. For instance, suppose you buy US stocks or funds, in dollars, using GBP. What could happen?
One scenario is that your US equities rise in price over, say, 12 months. Over that time, the dollar rises relative to the pound. If you sell the equities, then you not only enjoy the capital gains, the released dollars can also buy more GBP than 12 months ago.
However, what if your US equities rise in price over 12 months (letting you sell them for capital gains) but the dollar falls relative to GBP? In this case, the released US dollars cannot buy as much GBP as before. Therefore, even though the investment account shows some nice returns generated by your equities, in real terms it is possible to break even – or, even lose money.
This is where a financial adviser can help. Navigating this aspect of foreign exchange can be complex are requires a robust, bespoke and long-term strategy which accounts for risks like these based on sound principles and up-to-date information.
If you are interested in discussing your own financial plan or inheritance tax strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
+34 966 460 407