For anyone with foreign exchange exposures, the recent fall in the value of Great Britain Pound will have had a significant impact.
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Clearly, a weaker GBP is positive for anyone holding foreign currencies. As well, exporters with goods priced in GBP, which are now cheaper for overseas buyers, should be experiencing a windfall. Of course, the opposite is the case for UK importers. (The latter being evidenced recently by concerns about the UK Ministry of Defence’s exposure to future military equipment orders from the USA, priced in US dollars, for which the GBP cost has increased by an estimated £700 million compared to pre-Brexit exchange rate assumptions.)
The weakness of sterling is a wider cause for concern as it has inflationary implications for the UK, ramping up the price of imported goods, raw materials and commodities at a time of eroding confidence in the UK economy and decreasing interest rates, which are normally raised to stave off inflation.
Uncertainty about the UK economy has dominated currency sentiment since before the Brexit vote in June, depressing it from the highs of 2015. However, the sharp fall on 24 June, of around 8%, caught most in the market by surprise, and the currency has continued to trade nervously in a lower range ever since. Lows like we haven’t seen for a while occur every time a further negative indicator is announced (see 5-year £/EUR chart below).
The market is currently trading in the 1.500 range and threatening to go lower. There is a historical precedent for such downward pressure in GBP. One might remember that following the financial crisis in 2008, GBP/Euro fell as low as 1.0602 in December of that year, after being at 1.5307 in January.
Even the unexpectedly rapid installation of a new post-Brexit vote, UK government has done little to reassure the markets or bolster sterling sentiment.
An interest rate cut and quantitative easing by the Bank of England have further undermined sterling, not least because it comes against a background of increasingly negative economic data and forecasts. Furthermore the Bank had waited for confirmation that the UK economy was slowing after the Brexit vote before deciding to ease, demonstrating their concerns were justified.
Ironically, low interest rates meant that the bank of England had trouble finding sellers of long-dated Gilts that it could buy back for quantitative easing, these being the only “safe” assets for institutional investors offering anything with a meaningful yield.
Business sentiment is negative, housing market indicators are causing concern and overseas investors are loathe to invest into such an uncertain environment. In many ways the currency seems to have become the leading indicator reflecting concerns about the UK economy, whilst others still remain mixed about the long-term impact of the UK leaving the European Union.
The question is whether current GBP weakness is a temporary phenomena or a long-term trend, and the answer to this lies largely in the performance of the UK economy and trade negotiations post-Brexit, for which we still await more information. Whilst most economists seem pessimistic about forthcoming UK economic data and many, including the Bank of England, predicted that a downward revision in GDP would be the inevitable outcome of a vote to leave Europe, it is still unclear how deep or lasting this will be, especially as it is possible that the new Chancellor of the Exchequer may ease fiscal policy if necessary and reduce the noose of austerity. Furthermore, there is still absolutely no clarity on the timing of or conditions of UK exit from the European Union.
In the long term, therefore, nothing can be certain and the currency may ultimately benefit from prolonged political and economic concerns about the Euro zone, political concerns in the US, or indeed some future reversal of the current declining trend in UK interest rates.
In the short term, however, it is hard to be bullish and there is a more obvious risk of further declines in the value of the currency.
In view of this, we are recommending those needing to buy euros and USD in the coming months to do so as soon as possible, either spot or forward, rather than wait for better levels. An alternative strategy is to buy some currency now to decrease exposure to a potentially worse rate in the future and hope to buy the rest on a short-term rally. However, waiting can be costly in such a volatile market. On 24 June, for example, £10,000 would buy Euro 13,100. A very short time later it would buy only Euro 11,800, a difference of Euro 1,300.
For those needing to convert foreign currency assets or receipts into sterling, there may yet be scope for better levels, but risk of short-term spikes, so this exposure needs to be carefully managed.
Premier FX offers customer focused and bespoke support to individuals and companies with foreign currency exposures to help them manage currency risk and reduce exchange and currency transfer costs. Please contact us if we can be of any help with this.
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This article was written on the 18th of August, 2016.