RiskFX Risk/CLSEuro spike may hurt UK treasuries

Euro spike may hurt UK treasuries

Treasuries should review foreign-exchange risks weekly or even daily as the euro rises further against the pound and dollar, industry experts have argued.

The euro has soared this week, following European Central Bank (ECB) President Mario Draghi stating he would delay any change to ECB monetary policy at least until September. Following the announcement at last week’s two-day ECB governing council meeting, the pound hit an eight-month low against the euro, and the dollar facing a 14-month low against the currency.

Following the announcement at last week’s two-day ECB governing council meeting, the pound hit an eight-month low against the euro, and the dollar facing a 14-month low against the currency.

“For a while now, the ECB has been navigating a period of quantitative easing (QE) to battle against low growth, unemployment and the burgeoning threat of deflation,” explains Natasha Lala, FX firm OANDA’s managing director.

“However, in recent times, it has shown signs that it will pull back on the QE reigns and end its mass bond-buying programme,” she says.

“The ECB’s policy had significantly strengthened the euro against the dollar, and any change to the [ECB monetary] programme in September could see the currency weaken which treasurers need to be mindful of from a cash management perspective,” Lala tells GTNews.

Exchange rate volatility: UK exporters’ biggest fear

The currency spike comes the same week as Lloyds Bank Commercial Banking published a survey finding almost half (48%) of Britain’s exporters haven’t reviewed their exporting strategies following the UK’s EU referendum in 2016.

This is despite the fact that the EU is a trading partner for 85% of firms that have exported in the past year, and is the region they have exported to the most in the last 12 months for 54%.

Industry experts have advised corporate treasuries to review their foreign exchange (FX) hedging strategies to check they are sufficient.

“Treasurers only have to look back at how the pound took a battering post-Brexit, and the peso plummeted following the election of Trump, to recognise the importance of having weekly or even daily views of risk exposure,” Mark O’Toole, vice president of commodities and treasury solutions at OpenLink, tells GTNews.

“Prior to the next big central bank move, treasurers need to be asking themselves is whether their hedging strategy is sufficient,” O’Toole says.

Last October UK sportswear company Sports Direct International warned that losses on its currency hedges could have a “negative impact of approximately £15m ($19m)”, if the value of the pound does not increase throughout 2017. Exchange-rate movements caused UK budget airline EasyJet to report its worst first-half loss for six years in the first half of 2017 as it took a £82m hit from the weaker pound.

Lala argues: “A spike like this has ramifications for any large British firm with export operations exposed to both the euro and dollar. A business will have to factor in a large array of costs, including materials, country-specific fees, wages in different currencies and so on.”

“The euro’s rally against the dollar is a timely reminder, if another one was needed, of the risks a general tightening of monetary policy can pose to any large business. For financial officers responsible for budgeting and forecasting, the euro’s bounce creates further uncertainty which most are all too aware of. Especially with Draghi’s comments not confirming either way whether or not quantitative easing (QE) will be dialled down until the autumn,” she says.

Exchange rate volatility was UK exporters’ biggest fear for the next five years, with 25% of those who have exported in the last 12 months rating it as their top challenge, Lloyds Bank found after surveying more than 1,000 exporting UK businesses of all sizes.

This challenge was closely followed by the potential introduction of trade tariffs, chosen by 19%.

‘The difference between quarterly loss or profit’

“Finance directors heavily exposed to euro/dollar will need to be able to retrieve accurate data for to forecast costs, understand cash flow, and budget accordingly. This could be the difference between an end of quarter profit, or loss,” Lala advises.

It’s hard to outline specifically what course the ECB will take in September, given the constantly changing economic and political conditions, admits Lala. But she argues that firms can use data to make educated guesses and plan accordingly.

“By combining this knowledge, and analysis of how rates reacted in similar situations from the past, which will help treasurers make informed decisions model and budget their spend next year,” she says.

While there are FX risks associated with international trade, it is vital for a robust economy. Lloyds reported that almost a third (30%) of surveyed UK businesses planned to focus on domestic opportunities instead of international trade. This creates a greater concentration risk on the UK economy and exposes companies to UK economic cycles.

Clive Higglesden, head of trade and supply chain product for Lloyds Bank Global Transaction Banking, said: “Wait-and-see is not really an adequate strategy for exporters, and businesses should be acting now to manage any risks on the horizon and possibly explore new opportunities. However, it is comforting to see that a quarter of firms are already looking at new markets beyond the EU which is important for ensuring reduced impact from any loss of access to the EU Single Market.

“For companies that have elected to focus on the UK, they need to be conscious that they will be more greatly impacted by UK business cycles. Diversification into new markets is an important way of managing this risk,” adds Higglesden.

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