Volatility and the British Pound: Where Does Brexit Take Us?

  • The announcement of a referendum regarding the UK’s exit from the EU has pushed the GBP to its lowest value since 2009; experts expect the GBP’s value to drop up to 20% in the event of a Brexit
  • The UK retail, F&B, clothing and textile, and manufacturing sectors are likely to be strongly impacted in the short term
  • In case of Brexit, many argue that the UK is likely to experience a significant fall in growth, jobs, and investment; several key sectors—such as construction, sports, and financial services—are expected to be hit significantly, while the stock market will be possibly plagued by high volatility
  • To mitigate exposure to GBP volatility in the coming months, industry professionals can adopt strategies such as undertaking natural or commodity hedging, setting baseline exchange rates with suppliers, and using data analytics or risk management models

How Did It Begin?

On February 20, 2016, UK Prime Minister David Cameron announced that Britain will hold an EU referendum on June 23, 2016, sparking fears of a “Brexit” (Britain’s exit from the EU). Popular politicians and celebrities alike have thrown their weight behind the campaign for and against Brexit, resulting in a plunge in the value of the GBP amid rising economic uncertainty.

In February 2016, the GBP plunged to $1.39—its lowest rate since 2009—and is currently (as of June 21, 2016) hovering around $1.46 (other reasons for the GBP’s weakness include the Bank of England’s reluctance to raise interest rates and the UK’s weak economic performance). Many industry experts argue that the GBP may witness profound declines in case Brexit comes through.

In this article, The Smart Cube aims to dissect the impact of a low GBP on key sectors in the UK, provide an overview of the impact on the UK in case of a Brexit, and discuss mitigation strategies to combat GBP volatility.

“With currency option pricing implying high probabilities of a further 10–15% fall in pound-dollar, it feels like in the short term we’ve perhaps reached a peak of Brexit Pessimism.” Jordan Rochester and Yujiro Goto, Currency Strategists, Nomura International (February 2016)

Today’s move (a drop in the GBP’s value to a three-week low due to surveys showing a pro-Brexit outlook) was a function of reality sinking in for overseas investors—the referendum will be a close outcome. We’re probably seeing some of those long post-Brexit pound bets unwind a lead for the ‘Leave’ campaign. – Viraj Patel, Foreign Exchange Strategist, ING Group (June 2016)

Which Industries will be Impacted by a Low GBP?

As seen in Figure 1, the retail, F&B, financial services, clothing and textiles, and manufacturing (including electrical, machinery, chemical, pharmaceutical, shipbuilding, aerospace, and automotive) sectors in the UK are likely to be strongly impacted in the short term due to the falling GBP.

Manufacturing

Most manufacturers in the UK are likely to breathe a sigh of relief, as a falling GBP is expected to encourage exports and help lift flagging demand in the sector. However, some manufacturers that rely on imported raw materials, such as metals, may be adversely impacted. Procurement and supply chain professionals in these companies should ensure that their risk management practices are robust and examine their supply base for signs of financial stress. In the near future, these manufacturers may keep order volumes low in an effort to adapt to lower demand, which can lead to supplier contract revisions.

Agriculture

A falling GBP is expected to be a boon for the country’s agriculture sector, which has been reeling under a six­year low in prices, partly on account of a strong GBP in the past few years. A plunge in the currency is expected to significantly encourage farm and red meat exports from the country. Further, a rise in domestic food prices should be beneficial for domestic producers. The weakness in the GBP has already resulted in a rise in lamb prices.

Tourism

Due to a weak GBP, the UK’s attractiveness as a tourist destination is expected to rise, especially for US tourists. In contrast, for UK tourists, overseas holidays (especially to the US) are likely to become more expensive. Travelers may switch to holiday destinations with more favorable exchange rates against the GBP—including Australia, Canada, South Africa, and Brazil.

F&B Importers/Manufacturers

According to industry experts, UK imports approximately half of its food consumption. A significant fall in the GBP’s value is hence likely to increase import costs for this sector. In some cases, F&B companies may be able to pass these cost increases on to customers—this is especially true in case of staples.

Electronics, and Clothing and Textiles Importers/Manufacturers

Products such as electronics, clothing, and textiles are primarily imported by the UK. A weakening GBP is likely to result in increased import costs, thereby leading to a rise in product prices or a fall in importers’ profit margins. In case of a price surge, the sales of these products are likely to take a hit, as these are discretionary purchases unlike F&B items.

Retail

Fluctuations in the GBP typically have a strong impact on the UK retail sector, as its supply chains span multiple geographies.

A rise in F&B prices may be a money-making opportunity for retailers, which may benefit from a surge in food inflation, leading to revenue growth and higher valuations. Further, retailers such as Tesco, which earn a significant portion of revenue from outside the UK, are expected to witness a windfall due to the weak GBP.

For apparel retailers, the impact is mixed. Premium brands, such as Tommy Hilfiger, Ralph Lauren, and Tiffany, are expected to raise their prices, thereby passing on cost increases to customers. However, affordable brands, such as H&M, Inditex, and Zara, are less likely to increase prices in order to remain competitive.

What are the Other Likely Impacts on Account of Brexit?

Business and Economy

Though the GBP is likely to be impacted the most, there are other areas that are also likely to be affected if Brexit were to happen. For instance, many argue that it would lead to a fall in growth, jobs, and investments in the UK. Further, it would hit UK living standards due to factors such as productivity slowdown and lower capital stock, wiping as much as 20% off the GBP’s value and shrink the UK economy by ~5% by 2030.

“Following a vote to leave, we think uncertainty could grip the UK economy, triggering a potential slowdown in growth and a collapse in the GBP by a further 15–20% against the dollar, with ~33% probability.”HSBC (February 2016)

Several sectors—such as tourism, financial services, and automotive—would be hit significantly, and ~550,000 jobs are likely to be lost by 2020. A Brexit could even trigger companies to move base (and hence, capital) away from the UK due to factors such as difficult regulations and reduced earnings (due to a weak pound).

“Due to Brexit, foreign investment is likely to slow. Multinational companies invest here for a number of reasons—language, infrastructure, educated workforce, etc. Being in the EU and being able to conduct Europe-wide business from the UK is a major incentive (for the companies).” Anthony Robinson, ‎Principal Campaigns and Communications Adviser, Confederation of British Industry (June 2016)

“If Britain left the EU, it would have to draw up new regulations governing telecommunications and other businesses. Along with an expected fall in the pound, it would lift costs for mobile operators. The concern is that the economy in Britain is driven by services and by growth in the digital space. If our input costs for delivering digital go up, then that would make the UK less competitive.”Ronan Dunne, CEO, Telefonica UK (May 2016)

“I’m with the 99 out of 100 FTSE CEOs that believe that a Brexit would be completely stupid. I think ‘stupid’ is probably the right word. It’s a strong word, but it’s true. I haven’t managed to find the one CEO (out of 100) who is pro-Brexit, but I guess his business is based entirely in the UK and is not on an international basis.”Patrick Thomas, CEO, Covestro (February 2016)

Banking, Stock Market, and Real Estate

Further, according to industry experts, the Brexit may lead to a fall in the S&P 500 and banking stocks by as much as 5% and 8%, respectively, while volatility in the overall stock market could rise up to ~40%.

“Anxiety about the Brexit triggered the FTSE 100’s steepest daily fall since mid-February. In just four days, more than ~$141 billion has been wiped off the value of Britain’s biggest companies.” – The Telegraph (June 2016)

Moreover, a Brexit is likely to have a profound adverse effect on the UK’s real estate market. Property prices are likely to crash 10–30%, dragging the UK banking sector along.

“The Centre for Economics and Business Research suggests that Brexit could cause UK house prices to drop by an average of ~$2,871, coupled with a fall in the stock markets. Trade bodies representing estate agents and landlords suggested Brexit would cut rent bills as immigration levels would drop, shrinking rental demand. There would also be a resulting knock-on impact of a skills shortage of construction workers.” The World Post (May 2016)

Sports

The UK sports environment—especially for cricket, rugby, and football—may change radically in case of a Brexit, as more than 400 players may lose the right to play in the UK. This may diminish the quality and attractiveness of several championships—such as the Premier League and Aviva Premiership—which heavily rely on foreign talent. Even foreign coaches may find it harder to seek work in the UK. Further, a Brexit may lead to increased cost pressures for the sports community due to the imposition of trade tariffs on sportswear or sports equipment, as well as by cutting off of access to various EU funding streams—such as the Erasmus+ program.

“We're talking about half of the Premier League needing work permits (if Brexit happens). The short-term impact would be huge, but you could argue it will help in the long term as it could force clubs to concentrate on home-grown talent.”Rachel Anderson, Football Agent (March 2016)

“A Brexit could have a big impact on foreign players, as two-thirds of European stars in England would not meet automatic non-EU visa criteria, and therefore, might be forced to leave… Fans will also foot the bill by having to stump up extra for visas and possibly more expensive flights.” – Karren Brady, CEO, West Ham United Football Club (January 2016)

Sectors such as scientific research, farming, higher education, and security and defense may also take a hit in case Brexit becomes a reality.

What are the Mitigation Strategies?

Companies that operate complex international supply chains are likely to be heavily impacted by currency volatility. Even for companies that enter into contracts solely in their local currency, foreign suppliers typically factor in currency risk in contracts. Further, poor volatility management may lead to companies losing out on cost-saving opportunities when exchange rates move in their favor.

In light of increasing instances of high currency volatility (including the decoupling of the CHF from the EUR), The Smart Cube suggests the following strategies to address this issue:

  • Adopting natural or commodity hedging techniques
  • Transacting in currencies that are pegged (or move in parallel) to the company’s domestic currency
  • Setting baseline exchange rates with suppliers
  • Maintaining multiple suppliers (both local and foreign) and switching contracts as per currency movements
  • Using risk management tools/models and data analytics to predict currency exposure
  • Entering into short-term spot contracts in times of low or declining prices

These strategies are aimed at enabling industry professionals to fine-tune their businesses to be more resilient. What remains to be seen is whether they will be able to successfully integrate these strategies into their long-term vision and navigate market turbulences to stay ahead of the game.

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