The EU referendum and its impact on Sterling exchange rates

Here, Jonathan Watson looks at how a potential Brexit might affect small businesses.

Following the recent falls in the value of the Pound it seems appropriate to look at the possible impact of the Brexit on Sterling exchange rates.

Political uncertainty is one of the key drivers of exchange rates and there is nothing more politically uncertain than the prospect of the UK leaving the European Union.

One of the main headaches for businesses is the uncertainty over how the Pound will react and how this will directly impact their profit margins.

Businesses with a heavy reliance on import and export will be impacted by strong currency fluctuations.

What is the Brexit and how will it affect small businesses?

The Brexit refers to Great Britain exiting the European Union, of which it has been a member since 1973.

Over the years what started as loose agreements on trade between European nations has developed and evolved into a very deep and close economic, political and legal union.

This relationship is crucial to the UK’s global standing and influence, but has many critics suggesting it is out of date and costs the UK more than it is worth.

The UK is seen as a gateway to Europe both geographically and because of the widespread use of the English language around the world.

Like or loathe the UK’s close relationship with the EU, it is now a very important and integral part of the UK economy, and just like any long-term relationship, breaking up has consequences.

Many believe the UK would be ‘stronger’ after the break up but with so many new relationships to form there would surely be a gross negative impact in the short term.

It is not just the result of the referendum that is a cause for concern though. The most volatile time might be in the run up to the referendum.

With the date of poll between now and 2017, the uncertainty could drag on for months.

Uncertainty from overseas clients might prevent them from placing orders

Forty percent of UK trade is with the Eurozone so uncertainty from overseas clients and suppliers as to how the Pound will react may prevent them from placing orders or even entering into dialogues until the Brexit question is dealt with.

Who wants to place an order for delivery in the next 6-12 months when there is no guarantee the UK will still be in the EU? By then the business landscape may have completely changed. The GBP/EUR exchange rate has dropped 10 per cent since November which will be creating headaches for many UK businesses who import from overseas and sell into the UK.

We don’t even have a date of the referendum yet so this is likely to get worse and present more problems for small businesses trying to cost the future.

Many businesses conducting overseas trade will use an exchange rate clause in their contracts, for example a renegotiation on price if the exchange rate moves by more than 5 per cent. This allows suppliers flexibility in re-quoting if, for example they buy their goods in Euros but sell in Pounds.

Considering the Pound has dropped about 7 per cent against a basket of currencies in 2016 many small businesses who want to purchase from overseas are seeing their cost base rise. The worry of a ‘Brexit’ will be causing delay and adding an extra level of strategy in planning for the future.

These changes might not only directly impact the individual business but it could also impact one of the main customers or suppliers in the UK.

For example, a piping and fitting firm based in the UK which sources raw materials from a UK based sheet metal fabricators could have issues if the fabricators suddenly faced difficulty because of a change in its terms to import from overseas.

Small businesses reliance on a narrower base makes them more susceptible to changes around them, the wider negative impact on the UK and Sterling will hurt smaller businesses more because they can be more vulnerable to sharp shocks.

Pound Sterling weakness is not necessarily a bad thing

There are always winners and losers on exchange rates, even if not in equal portion. The winners of the recent and future GBP losses are small businesses who export goods to the Eurozone, since their products or services have now become 10 per cent cheaper.

Although exchange rate clauses could prevent the overseas purchaser from paying too much and might mean they have to lower their Sterling price to win the deal.

Assuming there is a ‘Stay’ vote in the EU referendum, the Pound should rise and confidence should increase, which will present fresh opportunities to secure business.

An opportunity to tap into new overseas markets does arise for business during times of GBP weakness as businesses looking to gain new overseas clients can use the weaker Pound to provide very competitive quotes. Previously inaccessible markets or clients could now be sought out.

Sterling weakness also offers overseas investors the opportunity to invest in the UK. Despite the initial shock of a possible ‘Leave’ vote in the EU referendum the UK is unlikely to just wither away from its place in the world.

Some canny overseas investors who can spot an opportunity will likely seize on this to buy or invest in the UK.

Business needs clarity and simplicity

Ultimately business wants to know what the future holds! Confidence is key and with the possible decoupling from the EU, which comprises such a large portion of UK trade, there is tremendous uncertainty which is not good news for business.

The Pound has been performing well in recent years and the UK economy growing at a steady pace. Unemployment has been falling and the UK economy has been coughing and spluttering into life from the dark days of recession.

This referendum and the worry leading up to it is not in my opinion good on the whole for the Pound, but as for some small businesses this is not necessarily a bad thing and longer term whatever the outcome, the UK will remain one of the world’s leading economies with great influence.

This referendum is not ideal but armed with good information business leaders can plan for most eventualities and ensure they are best placed to drive their business forward for the future.

The impact on Pound Sterling exchange rates

To work out what might happen it is usually a good idea to look at what has happened in the past. The Pound was sharply sold off in September 2014 ahead of the Scottish referendum, and Sterling suffered again in May 2015 in the build-up to the UK General Election.

Both of these events saw the Pound sold off in the weeks close to the decision before surprise results saw Sterling strengthen against most currencies, back to the levels seen before the uncertainty and higher in some cases.

The Pound has already experienced some big selling pressures since the beginning of 2016; this is in part down to the worries over the Brexit. This uncertainty is likely to linger and cause unexpected movements as investors react to the news.

There is very little known at this stage and the Sterling’s value will fluctuate as we learn more. February is a key month as we have the EU Summit and might even learn of a date for which the referendum will be held.

Can we trust the polls?

When looking for news to influence decisions to buy or sell Sterling the polls will undoubtedly play a significant role in determining GBP strength or weakness. Essentially, signs of the UK remaining part of the EU should help the Pound, signs of the UK leaving shouldn’t.

Will it be that simple in practice? It’s unlikely. One of the most notable points about the 2015 General Election was just how wrong the pollsters got it.

Right up until the exit polls, all the polls pointed to a hung parliament with most supporting a Labour minority government. I think while all of the polls will be treated with a little more caution, they do offer the best information available and will therefore play an important role in shaping Sterling exchange rates

If Cameron fails to negotiate a favourable new position then he will be likely to support the ‘Leave’ campaign, which could lead to GBP weakness.

The EU and Eurozone leaders did not respond well to Greece’s referendum earlier this year. Despite the Greeks voting to reject the bailout package, the Eurozone held firm and in the end the Greek government was forced to backpedal and accept.

The EU is no stranger to the negotiating table and the UK could easily find itself on the back foot in negotiations, leaving investors seriously troubled to be holding the Pound.

So, what should we expect?

Preparing for Pound Sterling weakness should be the overall position, but markets will react to the key events and news as it develops; expect volatility around polls and announcements on the renegotiation and the referendum date.

The Euro may also come under pressure, but not as much as the Pound.

Once dates and polls are clear the market can take shape and direction. A ‘Stay’ result should see the Pound rise significantly whilst a ‘Leave’ result will see the Pound weaken, but perhaps not too dramatically if this has been predicted in polls. The shock factor and surprise is what usually moves the market in such a way and the EU referendum is likely to contain plenty of both.

Further reading on Brexit

Related Topics

Brexit

Leave a comment

Your email address will not be published. Required fields are marked *