Friday 28 October 2016

Comment: Irish exporters need to be braced for more sterling headwinds this year

John Moclair

Published 11/08/2016 | 02:30

An employee walks over a pound symbol in the Bank of England, which is taking post-Brexit action
An employee walks over a pound symbol in the Bank of England, which is taking post-Brexit action
John Moclair, Bank of Ireland

Sterling has continued its move lower this week, as the Bank of England commenced the first round of asset purchases as part of the package of easing measures announced last week.

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That package consisted of a comprehensive array of easing measures including a 25bp rate cut, £10bn purchases of corporate bonds, £60bn of purchases of UK government bonds and a funding facility for banks to ensure policy transmission to the real economy.

This shopping list of actions exceeded market expectations and highlighted the aggressive stance the UK Central Bank is taking.

These measures have been designed to mitigate the possible economic fallout of the UK's decision to leave the EU and a consequence of these actions may well involve large exchange rate moves versus the UK's trading peers. From the UK's perspective, the weakening pound has so far been a welcome counterbalance for the predicted slowdown in the economy, buoying domestic exporters and pushing the FTSE 100 index of UK stocks to year-to-date highs.

A weaker pound also helps to prevent the UK's current-account deficit, which is one of the largest in the developed world, from rapid deterioration.

The depreciation in sterling should also support net trade volumes over the near term, while higher import prices should drive UK consumers and businesses to substitute towards domestically produced goods and services.

This is how quantitative easing should work.

Since the initial knee-jerk reaction to the EU referendum vote, sterling has consistently weakened as the probability of monetary easing has become reality and market consensus is now for further easing measures in the coming months.

Earlier this week, Bank of England board member Ian McCafferty indicated that further rate reductions and additional QE purchases may be required if the UK economy shows further signs of a slowdown.

The pound has depreciated by over 20pc against the euro since the start of the year, back to levels not seen since 2013.

In doing so, it has reversed a move in the euro that took the ECB years to engineer. The magnitude of this change with €1 now buying just below 86p has been destructive for European exporters to the UK, but so has the speed of the move; where un-hedged positions can erode margins.

The fall in sterling will undoubtedly have been a major headache for Irish corporates and exporters over the past weeks, in particular those with large exposures to the UK market as they try to decipher what the new fair value for the pound will be.

History will not provide much solace as currency trends generally play out in waves that can span years. Also, the current depreciation is still much smaller than the move witnessed at the onset of the 2008 financial crisis when the pound traded up to 98p.

All this points to a very difficult environment for Irish businesses trying to navigate their sterling exposures, as large swings of the exchange rate remain likely in the second half of 2016.

In such an environment, it is more important than ever for businesses to establish their approach to currency management, including being very clear on what the business needs and is striving to achieve from such activities. Added to this, discipline in executing agreed currency strategies is crucial. Without doubt, much of this planning and execution takes valuable time, time that is scarce for many businesses, but it will pay off in the medium term to minimise the business risk that stems from FX moves.

John Moclair is head of global customer group, Bank of Ireland global markets

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