Brexit – How Could It Effect Rates Of Currency Exchange? And What Could This Mean For Your Business?

Brexit – How Could It Effect Rates Of Currency Exchange? And What Could This Mean For Your Business?

1000 1000 Nick Hyde

Brexit – How Could It Effect Rates Of Currency Exchange? And What Could This Mean For Your Business?

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Following the recent falls in the value of the Pound it seems appropriate to look at the possible impact of the Brexit on Sterling exchange rates. With the EU referendum looming on the 23rd June 2016, being prepared for the result, either way, can mean the difference between profit and loss.

Political uncertainty is one of the key drivers of exchange rates and there is nothing more politically uncertain than the UK’s decision about its future relationship with the European Union. One of the main concerns for businesses is the uncertainty over how the Pound will react and how this will directly impact their profit margins. Businesses with a heavy reliance on import and export will of course be impacted by strong currency movements.

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What is Brexit and how will it affect small businesses?
‘Brexit’ refers to Great Britain exiting the European Union, of which it has been a member since 1973. Over the years what started as loose agreements on trade between European nations has developed and evolved into a very deep and close economic, political and legal union. While its proponents argue that this relationship is crucial to the UK’s global standing and influence, its critics claim it is out of date and costs the UK more than it is worth.

The UK is seen as a gateway to Europe both geographically and because of the widespread use of the English language around the world. Like or loathe the UK’s close relationship with the EU, it is now very much a part of the UK economy, and just like any long-term relationship, breaking up has consequences. Many believe the UK would be ‘stronger’ after the break up, but with so many new relationships to form there would likely be a negative impact in the short term. It is not just the result of the referendum that is a cause for concern though. The most volatile time might be in the run up to the referendum.

Uncertainty from overseas clients might prevent them from placing orders.
Approximately 40% of UK trade is with the Eurozone, so uncertainty from overseas clients and suppliers as to how the Pound will react may prevent them from placing orders or even entering into dialogues until the Brexit question is dealt with. Who wants to place an order for delivery in the next 6-12 months when there is no guarantee the UK will still be in the EU? By then the business landscape may have completely changed. The GBP/EUR exchange rate has dropped 10 per cent since November, which will be creating headaches for many UK businesses who import from overseas and sell into the UK.

Many businesses conducting overseas trade will use an exchange rate clause in their contracts, for example a renegotiation on price if the exchange rate moves by more than 5 per cent. This allows suppliers flexibility in re-quoting if, for example, they buy their goods in Euros but sell in Pounds. Considering the amount the Pound has dropped against the Euro many small businesses who want to purchase from overseas are seeing their cost base rise. The worry of a Brexit will be causing delay and adding an extra level of strategy in planning for the future. Small businesses’ reliance on a narrower base makes them more susceptible to changes around them, and the wider negative impact on the UK and Sterling could hurt smaller businesses more because they can be more vulnerable to sharp shocks.

Pound Sterling weakness is not necessarily a bad thing.
There are always winners and losers on exchange rates. Predictions from large investment banks have been that a leave vote could see the pound drop as much as 15% to 20% against other currencies.

But is that a bad thing?

There are potentially positive implications of a lower currency; for example, export growth. A country’s exports can gain market share as its goods get cheaper relative to goods priced in stronger currencies. The resulting increases in sales can boost economic growth and jobs, as well as increase corporate profits for companies that do business in foreign markets.

Inflation can climb when economies import goods from countries with stronger currencies, since it takes more of a weak currency to buy the same amount of goods priced in a stronger currency. Currently, low economic growth has resulted in deflation, or falling prices, which is becoming a bigger risk than inflation in many countries. Many of the countries in the EU have been combating this issue for years. A deflationary mindset is undesirable because once consumers begin to expect regular price declines, they may start to postpone spending and businesses may begin to delay investment, resulting in a cycle of slowing economic activity.

An opportunity to tap into new overseas markets does arise for business during times of GBP weakness too, as businesses looking to gain new overseas clients can use the weaker Pound to provide very competitive quotes. Previously inaccessible markets or clients could now be sought out. Sterling weakness also offers overseas investors the opportunity to invest in the UK. Despite the initial shock of a possible ‘Leave’ vote in the EU referendum the UK is unlikely to just wither away from its place in the world. Some canny overseas investors who can spot an opportunity will likely seize on this to buy or invest in the UK.

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Business needs clarity and simplicity.
Ultimately a business wants to know what the future holds! Confidence is key and with the possible decoupling from the EU, which comprises such a large portion of UK trade, there is tremendous uncertainty which is not good news for business. The Pound has been performing well in recent years and the UK economy growing at a slow but steady pace. Unemployment has been falling and the UK economy has been coughing and spluttering into life from the dark days of recession. This referendum, and the concerns leading up to it, may not necessarily be good for the Pound, but as for some businesses this might not be a bad thing and longer term, whatever the outcome, the UK will remain one of the world’s leading economies with great influence.

The impact on Pound Sterling exchange rates.
To work out what might happen it is usually a good idea to look at what has happened in the past. The Pound was sharply sold off in September 2014 ahead of the Scottish referendum, and Sterling suffered again in May 2015 in the build-up to the UK General Election. Both of these events saw the Pound sold off in the weeks close to the decision before surprise results saw Sterling strengthen against most currencies, back to the levels seen before the uncertainty and higher in some cases.

The Pound has already experienced some big selling pressures since the beginning of 2016; this is in part down to the worries over Brexit. This uncertainty is likely to linger and cause unexpected movements as investors react to the news. There is very little known at this stage and the Sterling’s value will fluctuate as we learn more.

Can we trust the polls?
When looking for news to influence decisions to buy or sell Sterling the polls will undoubtedly play a significant role in determining GBP strength or weakness. Essentially, signs of the UK remaining part of the EU should strengthen the Pound, while signs of the UK leaving should weaken it. As we’ve said previously, both scenarios have their advantages.

Will it be that simple in practice? It’s unlikely. One of the most notable points about the 2015 General Election was just how wrong the pollsters got it. Right up until the exit polls, all the polls pointed to a hung parliament with most supporting a Labour minority government. While all of the polls will be treated with a little more caution, they do offer the best information available and will therefore play an important role in in the movement of the Pound.

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So, what should we expect?
Preparing for Pound Sterling weakness should be the overall position, but markets will react to the key events and news as it develops; expect volatility around polls and announcements on the renegotiation and the referendum date. The Euro may also come under pressure, but not as much as the Pound.

A ‘Stay’ result should see the Pound rise, while a ‘Leave’ result will most likely see the Pound weaken, but perhaps not too dramatically if this has been predicted in polls. The shock factor and surprise is what usually moves the market in such a way and the EU referendum is likely to contain plenty of both. This referendum is not ideal, but armed with good information businesses can plan for most eventualities and ensure they are best placed to drive their business forward for the future.

Nick Hyde
AUTHOR

Nick Hyde

Nick Hyde of Live Financial Foreign Exchange based in the City of London - a boutique brokerage helping companies increase profit through currency exchange solutions. Authorised and Regulated by the FCA and HRMC. Available for both private and corporate clients. I'm still hunting for that crystal ball so I can answer the most commonly asked question: what are the exchange rates going to do! Ask me about a free review and proposal for your clients.

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