Posted on Wednesday 24 February 2010 byUlster Business
For those trading south of the border or further afield, movements in the value of sterling can have a huge impact on profit margins. James Beattie, relationship manager with First Trust Bank’s Global Treasury Services, takes a look at how to manage a key factor in the exporter or importer’s armoury.
Gloomy appears to be the word most frequently used to describe the UK economy at present and there appears to be no immediate prospect of a change in sentiment. In January, the headlines that dominated the financial press were all fairly negative. These included the fact that the UK limped out of recession as the economy grew by a mere 0.1% in the final quarter of last year. In addition, it was proclaimed that we have endured the deepest recession since the Second World War. Not particularly encouraging stuff.
It is clear that all sectors of the local economy are experiencing difficult conditions. The housing market remains under significant pressure, there is a growing question mark regarding the strength of consumer demand, mounting concerns over the health of the public finances, and the labour market remains tight. Yes, belt tightening appears to be the order of the day.
Perhaps surprisingly, given the economic weakness, Sterling has managed to claw back some lost ground versus the Euro. It moved back above the €1.15 level at the end of January. This was a five month high as demand for the UK currency increased on the back of growing market concerns about the risks to the Euro from the uncertainty over Greek fiscal policy. There is continuing speculation that the Euro will remain under short-term pressure due to the fiscal challenges facing not just Greece, but also Ireland and Portugal.
Sterling faces an important test over the next few months; the forthcoming General Election could produce a period of volatility as the markets worry about the far from certain outcome. Secondly, concern is growing over the new government’s plans to tackle the UK’s serious fiscal problem. This is a priority for either a Labour or Conservative government as the UK is under the spotlight by the rating agencies. A sovereign downgrade is not out of the question which would have a negative impact on Sterling.
The weakness of Sterling against the Euro in 2009 had positive implications for Northern Ireland, as it attracted significant levels of consumers from across the border. With significant question marks over levels of disposal income for local consumers, the ongoing influx of shoppers from the Republic will be extremely welcome by local retailers.
The perception that Sterling trades in fairly tight ranges against the major trading currencies is clearly outdated (many readers will remember when the Pound versus Punt exchange rate pivoted around the parity level with a degree of fondness). Perhaps not surprisingly, Sterling volatility causes inevitable problems for local finance managers. There is no doubt that finance directors and financial controller’s desire currency stability. Recent foreign exchange volatility has presented a challenge both for exporters and importers alike.
Companies who import products or services from the ‘eurozone’ should take a long, hard look at their pricing policy. Any business that is not managing its foreign exchange requirements closely could be in for a nasty surprise when it comes to paying for imports. Some companies try to avoid paying suppliers in the hope that the exchange rate improves. This can often cause real damage to the importer – supplier relationship.
Importers who continue to avoid currency losses on their operations are those that utilise current market rates when formulating prices and immediately hedge their anticipated currency requirements when a deal with a supplier is struck. This enables the business to accurately predict future cash-flows and protects from further Sterling depreciation. It also helps to delay price rises at a time when competition for products and services is intense.
On the other side of the coin, exporters must also recognise the importance of effective foreign exchange management. The attractive levels currently available for conversion of Euro receipts may or may not last. However, it would appear prudent for local exporters to evaluate the benefits of ‘locking into’ current market exchange rates for future sales.
Local exporters often identify the ‘worst’ exchange rate that safeguards the minimum desired levels of profitability. If the Pound rises to this level (known as a ‘stop-loss’), the company should hedge at least a portion (if not all) of its anticipated exposure. This will ensure that good opportunities to exchange currency receipts are not missed.
Given the increasing economic volatility, effective management of currency exposures is now more difficult than ever before. Ignore it at your peril.