Published : 10 years ago, on 23/10/2014

Enrique Diaz-Alvarez, Chief Risk Officer, Ebury

We are often told that one of the hallmarks of a thriving economy is a strong and stable currency. After a strong couple of months for Sterling, the threat of Scottish Independence caused instability as the markets anxiously waited for the outcome. Once announced that the UK would remain together, Sterling roared back to life against its main trading partner, climbing to a two-year high. While stabilisation is good news for markets, any volatility the pound experiences has a major impact on British businesses trading internationally.

While some businesses reap the rewards of a strong pound, as we saw earlier in the year, several high profile British businesses blamed currency headwinds for diminishing profits. Preliminary results from drinks firm Diageo in July stated that the strong pound knocked nearly £350m off operating profits and firms such as Rolls-Royce, GlaxoSmithKline and WPP all reported lower than expected profits for the same reason.

Enrique Diaz-Alvarez

Prior to the ‘Yes’ vote momentum seen in the run up to the Scottish referendum, the pound had risen 11.3 per cent in the last year alone against the dollar and almost 10 per cent against the euro. While the big UK listed companies are struggling to meet their targets, little attention seems to be given to SMEs, who stand to lose much more from market volatility as the value of their exports is dented.

With Scotland remaining in the UK, a better than expected economic recovery and the prospect of interest rate rises just around the corner, the steady rise in the pound against the euro looks set to continue. The role played by UK SMEs in securing the national economic recovery is just as important as that of FTSE 100 businesses, if not more. A strong pound impacts all UK Companies who either export or import goods or services in foreign currencies.

Exports vs Imports

British companies exporting goods may find their products become too expensive for international buyers, especially if they are operating in highly competitive markets. Large British brands seeing their exports affected by this trend are often protected by their notoriety and deep customer relationships. SMEs however, may find themselves passed over for cheaper options or even forced to lower prices.

According to a manufacturing survey by the Confederation of British Industry (CBI), while domestic orders of goods and services has surged by 23% in the last quarter, export orders have fallen flat, despite having increased by 16% over the previous period. If the economic recovery is to be balanced, a strong export market is essential.

Despite these negative impacts, many UK companies actually stand to benefit from the pound´s strength against most other currencies. Companies who import to the UK have greater buying power abroad thanks to a stronger currency and can set favourable prices, making them more profitable. The rise in the strong pound can have both positive and negative effects on SMEs, depending on whether they import or export goods from the UK and how well they prepare for fluctuations on either side.

It is important to remember that currency fluctuations are not something that happens overnight and there are ways in exporters can navigate these storms and soften the full impact. Scottish Independence, for example, was a well-publicised event, which Companies had time to plan for and watch closely as matters unfolded. Predicting and hedging against the risk of FX movements allows a company to prepare for the impact this will have on profits. UK SME exporters also need to consider how they compete on a global level and plan for this accordingly.

The need to balance a strong pound with the requirements of exporters seems to be recognised in Government and the situation is improving. Chancellor George Osborne reiterated his commitment to British businesses in this year’s budget, claiming that exporters are at the heart of the Government’s economic agenda, while the Bank of England is also taking this into account when looking at the timing for interest rates rises.

With Sterling set to outperform in the coming months and reclaim some of its lost ground experienced during the Scottish referendum uncertainty, the balance tips back into the importers favour. Exporters will face much of the same conditions they saw before and will need prepare accordingly, importers meanwhile will be able to able to reap the rewards for a little while longer.