What does forex volatility mean for UK businesses?

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Date: 21 January 2020

A small business owner worries about the impact of currency fluctuations on his firm’s operations.

Many British businesses will be hoping that the New Year finally brings an end to a period of prolonged volatility for the financial markets.

Market volatility has always been something UK businesses have had to contend with, but Brexit fears have caused unprecedented uncertainty since the shock decision by UK voters to break away from the European Union in June 2016.

Since then, both sterling and the FTSE 100 have echoed the instability felt by many businesses, although recent rises have brought renewed hope that an end to the volatility could soon be in sight.

The forex volatility caused by Brexit 

After an initial fall, the British Pound (GBP) recovered in the weeks following the vote to leave the EU. However, comments made by the French President Francois Hollande in October 2016 led to a flash crash that saw the pound fall by more than 6% against the dollar in a matter of minutes.

Although the pound rebounded at the start of 2017, Theresa May’s decision to call a June election backfired when her Conservative party was unable to form a majority government, and that further weakened the pound.

In 2018, new directives from the EU27 led to a further drop of 4.42% over six weeks for GBP-USD, and sterling continued to weaken as Brexit talks began to stall. Continued uncertainty led to the pound closing in a weakened position against the dollar and the euro by the end of the year. 

2019 brought better news, with both the FTSE and GBP rebounding early in the year. However, as the growing threat of a no-deal Brexit grew, the pound started to fall. At the end of the year, a general election win for Boris Johnson and the creation of a comfortable Conservative majority caused the GBP to soar on the back of renewed hope that reaching a withdrawal agreement would be easier.

The impact of forex volatility

As a net importing country, UK businesses are vulnerable to any depreciation in the value of the pound, particularly when you factor in the effect of Brexit uncertainty.

Although variations in the strength of the pound can work in favour of export businesses, the underlying volatility has made it difficult for businesses to secure the best rates when making international payments, which has threatened to wipe out any gains they have made.

Data from an international payments company has revealed the impact of shifting exchange rates. It found that the 5.3% movement of the GBP against the EUR in 2018 equated to more than £12bn being recorded as either a loss or gain on UK businesses’ balance sheets. The extent of their gain or loss depended on their currency exposure and the timing of forex trades. 

How has forex volatility affected British businesses?

Broadly speaking, there are four ways in which forex volatility impacts British businesses.

Supplier payments

A weak pound can be a significant headwind for British businesses when paying international suppliers. Every percentage change in the exchange rate can have a direct impact on the bottom line, with a weak pound leaving businesses out of pocket and a strong pound allowing businesses to get more for their money. 

Attracting foreign buyers

For British businesses that sell to overseas customers, a weak pound can prove to be a big benefit. It helps to make British products more competitive to international buyers, leading to an increase in export orders.

Sales forecasts

Forex volatility can also be problematic for multinational companies that operate in or are based in the UK. Sales forecasts listed in another currency can easily be wiped out if an exchange rate moves against a business, or provide a boost when it shifts in the business’ favour. 

Balance sheet hedging

British businesses that hold assets and liabilities in more than one currency will know that forex volatility can be a burden. Fluctuating exchange rates can lead to sharp revaluations of an asset or liability. For example, a loan taken out in US dollars before the EU referendum, when GBP reached 1.49 against the dollar, will be a far greater liability now.

The world is increasingly global

Although many British businesses will be happy to see the back of forex volatility caused by the Brexit negotiations, the subsequent trade deals and ongoing geopolitical developments mean that periods of forex volatility are never too far away.

Copyright 2020. Sponsored post made possible by Paul Robinson, DailyFX.

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