The Brexit hysteria has quietened down lately due to the fact Article 50 won’t be triggered until next year, we’ve managed to secure a new Prime Minister and recently, there hasn’t been too much to be hysterical about.
Hysteria or a mild form could be around the corner however, all the latest economic surveys point towards severe weakness in the economy and the Bank of England has cut interest rates. Despite some benefits to the export market a weak pound is overall a bad thing for the UK since as a net importer the UK has to buy more from overseas than it sells overseas.
Confidence is what drives business leaders to make the decisions on investment, employment and spending that boost the economy. Until we get clarity on what Brexit actually means, confidence will be in short supply. Brexit will potentially open new fresh opportunities for the country but for now until we can understand and assess the detail, it is tricky to measure the potential gains against the immediate uncertainty.
Brexit winners and losers
There will be changes over the coming months and years that will likely impact business decisions, the most obvious to arise in the wake of Brexit is the fall in the Pound’s value. Most businesses that rely on imports or exports are impacted by a weaker Pound. However exchange rates implications can indirectly impact all manner of businesses. For example a big manufacturer importing raw materials from the Eurozone might find it does less business because its raw materials costs rise because of a weak pound. Peripheral businesses reliant on that Manufacturer including IT companies, recruitment companies and even a local sandwich van will lose business if that main Manufacturer sees a decline or goes out of business.
Buying Euros and US Dollars with pounds is now roughly 10% more expensive than prior to the results, a cost that will have to be passed on down the supply chain. As explained above a weak pound has wider implications and many businesses from supermarkets to garden suppliers will all potentially have to raise prices to account for the increased cost base they are going to endure over time.
There is absolutely a flipside since investment in the UK has become significantly cheaper, much longer term this foreign investment could well ease some of the pain experienced in other areas of the economy. However since the UK purchases more overall than it sell overseas a weak currency is a bad thing. It is also reflective of a weak economy which generally means high unemployment and low growth. Unemployment is currently rock bottom and the economy is growing but for just how long will that keep going? For business the future is what matters and right now we just don’t know what is around the corner.
‘Brexit means Brexit’
Theresa May has insisted that she will make a success of Brexit, yet the UK Government haven’t even provided any details. What we do know is that Article 50 which is supposed to be the framework for leaving the EU provides a 2-year exit clause, this is supposed to be triggered by the end of the 2016 or early 2017. So we could be looking at late 2018, early 2019 as the earliest date for the UK’s exit to be ‘completed’.
There is plenty of speculation as to what Brexit Britain will look like because essentially there are so many options and theories at this point. There are a number of interests also to be balanced like for example whether the UK will retain access to the all-important single market and whether it will retain or reject the Free Movement of People principles that were so important in the Referendum debate.
A soft version would involve the UK accepting lesser membership from the EU in the form of EEA membership (European Economic Area), also referred to as the Norway option. EEA membership could be an easier option for the UK given the complexities unravelling 4 decades of political, social and economic ties with the EU. A soft Brexit could keep most of the existing arrangements intact, whilst maintaining access to the single market.
Although this option is considered easier to implement, it would not sit well with a large portion of Brexit voters given how similar EEA and EU membership are. Most policies including free movement of people would remain untouched allowing for a continuation of existing arrangements.
It also assumes that the EU will provide a deal with the UK that is not considerably worse, given the current stance of a number of EU officials including Jean-Claude Juncker – President of the European Commission, the UK could be in for a very bumpy road.
Nevertheless, if the UK can get away with a soft Brexit and the deal provided by the EU meets the expectations of Brexit supporters, Pound Sterling will likely rise as confidence begins to build in the markets. GBPEUR could come up to the mid 1.20’s and GBPUSD could even flirt with 1.40 but this could be well into 2017 at its earliest, the pound is likely to lose more value in the short term as the UK economy declines further and the Bank of England consider further interest rate cuts.
Political uncertainty has been a key feature of Sterling weakness and were the UK to opt for essentially a worse version of what we already have then there could be strong calls for another Referendum on the new relationship or even a General Election. The Norwegian option cannot be said to be in line with what voters were sold by the Leave campaign.
A hard version of Brexit could put an end entirely to an EU or subsidiary membership, allowing the UK full control over who they trade with and to set the rules on borders. This option is favoured in some quarters although the economic pain is likely to be greater in the short term and the actual implementation could prove a logistical nightmare. Hard Brexit would see WTO (World Trade Organisation) rules invoked with extra tariffs on UK goods. In theory this option seems logically a smart move and meets the spirit of the Brexit vote and certainly the Leave camp rhetoric. In practice the UK would need to end up on the right side of winning support for a large number of new trade deals. At present the EU are setting a tough stance for fear of triggering or encouraging further members to leave the EU which will not bode well for negotiating this ideal. As with a soft Brexit as the plans become formulated this should help sterling rise as the political and economic uncertainty is lifted. The Hard Brexit probably carries more risk but could offer the best long term ideals. Were the UK to be able to retain a form of free trade with the EU and the rest of the world business would surely flourish.
What can be done?
Business can limit their exposure to foreign exchange swings utilising forward contracts which limit exposure to the market fluctuations by locking in current rates. This helps protect or hedge against the future and ensures businesses have certainty in their pricing for the future. This can be used by buying from overseas and businesses being paid from overseas to help mitigate against the movements. Other options include the use of exchange rate clauses in foreign currency quotes and orders (which provide for requotes where prices rates have changed over a certain percentage) plus the option to price goods by the supplier to encourage them to take the volatility.
The UK’s new relationship with the EU will more than likely be some form of mid-way compromise between a hard and soft Brexit. It is in neither the UK nor the EU’s interest to be overly difficult with each other. That is not to say the process is going to be easy, it is going to be difficult. There are lots of interests to satisfy and issues to tackle. Business flourishes when there is certainty as business leaders and decision makers can make decisions on investment with confidence. At present there is limited confidence because we just don’t know what is happening. The longer this persists the worse the impact on the Pound which whilst good for some businesses is reflective of a weaker economy. Longer term as business understands better the implications of the Brexit and the nature of the new relationship with the EU confidence will rise and with it the Pound and certainty for business. In the rocky interim period until this date is reached business should be planning for further falls in the value of the pound and understanding how it might impact their customers and suppliers.