Cash & Liquidity ManagementInvestment & FundingEconomyBalancing the risk of the currency exchange

Balancing the risk of the currency exchange

For UK treasurers looking to manage financial risk within their organisation, recent news of an interest rate rise from 0.25% to 0.5% was a mixed blessing.

Did the Bank of England’s recent rise in interest rates help or hinder the pound?

For UK treasurers looking to manage financial risk within their organisation, the recent news of an interest rate rise from 0.25% to 0.5% was a mixed blessing. The immediate response to the news from the Bank of England’s (BoE) Monetary Policy Committee (MPC) was a fall in the value of sterling against both the euro (1.18%) and the US dollar (0.75%). Usually an increase in the interest rate would bolster the pound, at least in the short term, but because the move had been anticipated, this first increase in a decade had already been priced into the market. As a result, there was nothing more to gain when the news became official. In addition, the note of caution from the MPC that any further rise may be similarly incremental in nature and some way into the future gave little hope for investors to push the pound higher.

For many organisations, this may not be the worst possible outcome. For organisations that have seen an increase in export sales as British goods provide excellent value to buyers in Europe and further afield, the latest dip could be good news. The pound has clawed back its losses since the news but at the time of writing has not moved any higher, which means that British exports may continue to be a great deal for the moment, at least. This is, of course, the last thing that importers of goods or components were hoping for. A rise in the value of the pound would have meant better value for resource investments at a time when commercial credit is likely to become tightened. Most treasurers will be taking a much longer view of the situation, however. The immediate change is less significant than what happens to the interest rate, and by extension, the value of the pound, in the longer term.

While the move by the MPC had been largely anticipated by the market, the unpredictable political news cycle means that it is not possible to know whether this change provides a foundation for a longer term upward move by sterling. There are certainly other factors at play; the recent pressure for the government to release the Brexit impact papers last week may provide some certainty, but equally may cause more confusion or even panic in the currency market. This, in turn, may influence or alter any future plans by the MPC. If you’re looking to provide more certainty within your business, you may want to further consider and continue to review your currency exchange policies to allow for the current market conditions. While you can’t control the fluctuations in the currency exchange or dampen the unpredictable global political news cycle at the moment, there are a number of considerations to help you manage your funds.

If you’ve been holding off on making international payments until the MPC statement was released, or perhaps hoping the Brexit impact papers would boost the pound with some clarity, then a spot contract may be the best option. Setting up numerous spot contracts each time you want to make a transfer isn’t always the most efficient way to manage your money across borders, but it’s a valuable facility for urgent payments.

If you’re taking a longer view, a forward contract allows you to secure a prevailing exchange rate in advance and can be held for up to three years (dependent upon the terms of your trading facility). Forward contracts may offer peace of mind on the end-value of a currency transfer. They are useful when planning a long term investment, meeting a recurring commitment for components or outsourced overseas services, and for effective budget planning. Please note forward contracts may require a deposit.

If you’re hopeful of future increases in the value of the pound but nervous about any potential drop in value, a market order may offer the best compromise between a spot and a forward contract. Market orders comprise both limit orders, which allow you to target a specific beneficial exchange rate you want to achieve and stop-loss orders, which identify the worst-case rate that you need to achieve. These two often work together on a one-cancels-other basis – a desirable rate can be targeted but if the market heads in a different direction, a stop-loss order can help to limit the damage by guaranteeing a minimum rate for the exchange.

If this last year has taught us anything, it has been to expect the unexpected and to assume nothing. The move by the MPC may yet turn out to be a positive development for sterling, or we may head into the New Year faced with more uncertainty on Brexit and accompanying fluctuations within the currency market.

 

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