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Why export benefit of falling pound will soon be eroded

Economy Watch by Brian Telford of Danske Bank

Published 11/10/2016

The PM is leaning towards a ‘hard Brexit’’
The PM is leaning towards a ‘hard Brexit’’

Much has been written in the past week about the pound sinking to lows against the US dollar not seen since the mid-1980s and several forecasters have also predicted a move to near parity between sterling and the euro. This fall has been accelerated by computerised trading which automatically triggered further selling when the pound fell below certain levels.

The pound is certainly weak relative to this time a year ago, dented by the ongoing uncertainty over the UK's economic future following the referendum vote to leave the EU earlier this year. With a pound worth €1.12 at time of writing, sterling has fallen to its lowest value since the 2008 financial crisis against the euro, and was at $1.24 against the dollar.

It's fair to say that trajectory has mostly been down to market uncertainty following the EU referendum and the lack of clarity on how the UK's economy will fare post-Brexit.

The old adage that markets hate uncertainty has been rolled out more than once.

Sterling probably wasn't helped last week by Prime Minister Theresa May's rhetoric at the Conservative Party conference in Birmingham with markets interpreting this as the strongest indication yet that she is leaning towards what has been dubbed a 'hard Brexit' - giving up access to the Single Market and full access to the EU customs union.

It could be argued that by committing to triggering Article 50 to begin the process of formally exiting the EU by March, Mrs May has provided the Government's clearest guidance so far. But her speech weakened the pound and sparked the above forecasts.

And yet a quick analysis of the predictions issued in the past two or three weeks by the major international investment banks and financial markets analysts serves as a reminder that it is not wise to assume the future direction of any currency pair is a one way bet.

In fact, predictions for the GBP/EUR currency pair are incredibly varied, ranging from those who expect it to drop to near parity at €1.02 to those who are expecting a sterling recovery and a rate of €1.35 in 2017. The predictions are surprising not in what they say but in the range, which I think confirms that, while there are lots of opinions out there, nobody really knows which way it will go.

That raft of opinions also provides a lot of scope for businesses here in Northern Ireland to fall into a familiar foreign exchange market trap - basing decisions on something because you like the sound of it.

If it suits you to hear an 'expert' say the pound is about to rise or fall, it can cloud the decisions you make. I've heard of businesses who haven't hedged against currency risk because they chose to believe a particular forecast that would have made them better off down the line.

Business leaders in Northern Ireland are, or should be, taking the currency effect into consideration in the running of their companies. But my advice would be that local businesses perhaps need to dig deeper into what is creating the currency risk in their business and look at their buying patterns. What is in their supply chain? How and when do they buy, and how and when do they pay? Can they look to different markets for materials? Are their competitors 'in the same boat' or is there some competitive advantage to be gained via an exchange rate windfall?

The recent sterling slump has benefited many local exporters, making them more price competitive. But ultimately that advantage will be eroded for anyone who buys materials from outside the UK that are used to create the finished goods that are then being exported back out of the UK. Even if they buy in Sterling there may well be some part of their supply chain which buys from the EU or elsewhere in the world, and this will eventually be reflected in GBP input costs. So don't assume that if Sterling is down 10 to 15%, that you will see all of that benefit. The net gain may be much less.

There is a chance that the pound could remain lower for longer against both the euro and the dollar.

Brexit and concerns about the UK economy have reduced the value of sterling against all the major currencies. But against the dollar there is the added dimension of interest rate fundamentals to suggest it will be expensive for us to go to America for the foreseeable future.

Analysts see the US in a more robust growth phase than the UK and the next interest rate move by the Federal Reserve is expected to be a rise, and this also supports a stronger dollar.

The flipside of sterling's weakness has, of course, been the rise in the FTSE 100 to record levels above 7000. Some of the investment driving transactions in the market is down to the fact UK companies look very attractive as sterling has weakened. But it's more complex than that. It should be acknowledged the initial run of economic indicators since the Brexit referendum results hasn't been as bad as was previously been forecast.

In fact, in some of the manufacturing and export data we have actually seen evidence of increased order books since the referendum as a result of the export boost from the weaker pound. It is understandable therefore that there would be a pass through from those positive outputs into the FTSE.

What that signals is that, for now at least, companies are just getting on with business. What else can they do? Even if Mrs May does stick to her proposed timeline, it will be spring 2019 before the UK is out of Europe. Businesses are in the midst of their current sales cycles, looking at the next 12 to 18 months and dealing in market as they see it now.

Not to sound too much like a politician, but there will be both challenges and opportunities. If current exchange rate conditions persist, exporters will hopefully continue to win new orders. At the same time, importers are facing additional exchange rate challenges.

If businesses understand the causes, extent and timelines of their exchange rate risk, they will be better placed to manage it effectively. But remember, simply doing nothing is not a strategy, choosing to do nothing, or choosing to do something is.

  • In next week's Economy Watch, we hear from Dr Esmond Birnie of the Northern Ireland economic policy centre

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