Theresa May, new prime minister, has said ‘Brexit means Brexit’ and now it’s time for businesses to start planning for it. We have already seen some big movement on sterling exchange rates but what is next and just how can businesses plan for the future?
Brexit has had instant drawbacks, notably the plummeting value of sterling from the economic shock, and prolonged uncertainty until it is clear what it actually means. The positives are less tangible at present but a weak pound, whilst not overly positive for the UK, makes inward investment in the UK more attractive and allows businesses to explore new markets with a lower cost base.
The success of Brexit will be largely determined by the deals struck between the UK, EU and countries overseas, coupled with the reaction and willingness of business leaders and people driving the country forward. As 99 per cent of UK businesses are small and medium-sized enterprises (SMEs) it is vital they are supported as it is their success which will provide stability for the UK on this bumpy road ahead.
Brexit and the bumpy political and economic road ahead
Theresa May has committed the UK to Brexit helping a light rebound from sterling’s slides of 13 per cent against the Euro and 15 per cent against the US dollar. There are always winners and losers from large currency fluctuations, however let us look at how sterling will react and the impact on business.
To make important investment decisions business leaders and decision makers need confidence about the future. I expect the pound to react in a similar fashion as prior to the EU Referendum reacting to the headlines and rising on good news, falling on bad. The Bank of England is likely to pencil in interest rate cuts for August and markets widely expect an expansion of quantitative easing (QE) too. The last time the Bank of England cut interest rates and initially launched their QE programme was in 2008-09 when the pound dropped to near parity with the euro.
An important bone of contention in this new relationship is access to the single market and allowing free movement of people; there are no deals to achieve access to the single market without allowing the free movement of people. The only example is the Swiss who voted in a 2014 referendum to restrict free movement, however the implementation of this failed due to the EU stating that doing so would result in Switzerland losing access to the single market.
Article 50 is the legal mechanism for leaving the EU and it states that in any deal the member who is leaving is not party to the negotiations. Ultimately it is for the EU to propose a plan which Britain has to then accept or reject. Until a new deal is agreed, the UK has a cloud of uncertainty hanging over it which will prevent and limit investment and reduce business confidence to take key spending and employment decisions.
With so much uncertainty as to what type of deal the UK gets and with the Bank of England poised to act to stimulate the economy we now need to look at the implications of a weak pound and what business can do to manage the shifts.
Is a weak pound good or bad for the UK?
The answer is that it depends on individual circumstances. Any UK manufacturer importing raw materials from the Eurozone has seen their cost base jump by 13 per cent since the EU Referendum. Most companies could not just absorb 13 per cent increase in costs, and profit margins would be hit. On the other hand, if you were a film producer whose production company has many US-based clients you have just been given a 15 per cent pay rise; the recent movements would have worked in your favour. Significant exchange rate fluctuations also affect companies in the production chain or businesses located near to the primary business impacted. An example could be an IT business whose main client is a local manufacturing business that is heavily reliant on importing raw materials from the EU. The IT business has no direct exposure to currency fluctuations however they could potentially lose their main customer because of currency shifts.
A weak pound is likely to be the result of financial stress and loss of confidence in other areas which causes negative impacts on the economy such as the loss of jobs, less confidence and reduced spending in the economy. Using UK export data from 2008-2009 (when sterling was at its weakest in recent years), Gross Domestic Product from the same period and finally the value of sterling, it shows that a significant fall in the value of the pound did not have a significant impact on increasing exports and improving GDP.
A weak pound gives a great opportunity for businesses to explore new prospects overseas and in different markets. With the pound likely to err on the weaker side for the next few months and perhaps beyond, now is the time to take advantage of a discounted UK. This has already been seen by overseas investors with the stock markets rebounding and some London-based estate agents reporting an increase in demand following the referendum.
How can businesses manage such risks?
Communication with key suppliers and customers in terms of exchange rate implications is important. Foreign exchange brokers will provide useful orders to help businesses plan and secure costs in advance utilising contracts such as ‘forward contracts’ where one can fix a currency rate in advance for a period of up to 18 months or more. This tool is available for both buyers and sellers of currency allowing exporters paid in a foreign currency to lock in current buying sterling rates to guarantee profit margins. In such cases it really does pay to be prepared; we have had many cases where certain businesses have not made firm plans on their currency exposure and have been caught out with a much increased cost base.
Exchange rate clauses in contracts are vital to avoiding difficult and potentially embarrassing conversations down the line that could disrupt further business opportunities.
The new deal is critical to the success of Brexit since access to the single market is vital to the UK economy. It helps support the SMEs that make up over 99 per cent of the UK’s businesses. While not all of them are exporting to the eurozone, any barriers to trade will have a negative impact on the ones that do and this will have wider economic consequences.
Looking at the Bank of England’s commentary, businesses should be preparing for rates to fall lower but also embracing and planning for new opportunities moving forward. The UK’s overseas suppliers and customers have not disappeared since June 23rd. Extracting the full potential from these relationships requires a strong government, some tough negotiating and an all-round tenacious determination to make it work.
Let us not forget that business leaders have been here before, we have only just picked ourselves up and dusted ourselves off following the financial crisis. From an exchange rate perspective, we have gone back about three years with most sterling rates including GBPEUR back to rates last seen in 2013, however the dollar of course is the exception having hit a 31-year low.
Businesses need clarity, simplicity and certainty. Unfortunately it will be many months and perhaps years before we get this certainty. From an exchange rate point of view, the pound could fall further so businesses should be braced to deal with it and making plans to use it to best exploit the future opportunities Brexit will offer.
Jonathan Watson is chief analyst at currencies.co.uk.
Further reading on sterling