It’s easy to get taken in with the media frenzy around the “downgrade drama”. After all, headlines such as “Pound’s slump to parity with the euro”, “The pound’s 31 month low against the US dollar” and “The pound sliding to a new 17 month low on the currency markets” are worrying for British business owners.
But has the impact of the credit downgrade been overplayed? And crucially, what will it mean for Britain’s SMEs?
In my view, the credit downgrade, in the short term, will not have any significant impact on UK SMEs. In theory, a credit downgrade should make borrowing more expensive in the UK. Yet, UK Gilts have actually increased in price and the yield is still at record lows. Despite Moody’s decision to downgrade, UK gilts are still in high demand and the Bank of England’s dovish monetary policy will continue to help keep borrowing costs down.
The Bank of England MPC meeting takes place this Thursday and there is a chance we may see further quantitative easing to try and stimulate the economy. We are likely to see interest rates remaining low and the cost of borrowing for SMEs will not increase.
But how will the downgrade impact in the currency markets? Since the start of the year the pound has dropped by eight per cent against the US Dollar, 6.2 per cent against the Euro and 5.3 per cent against the G10 basket of currencies.
A tough time ahead for importers
There is no doubt that Sterling weakness will make things much harder for importers and the volatility in the market creates difficulties when forecasting cash flows. The weakening currency will also increase inflation and therefore increase costs for SMEs.
However, although we have seen the pound weaken further since the credit downgrade, this was priced in to the market especially seeing as there was so much speculation it would happen.
The key is not to try and chase the market higher, but to look in detail about what short and medium term exposures look like. What’s the impact that further lower movements may have?
Despite seeing exchange rates that are widely below budget levels, the important thing now is to stem any further loss, re-group and work back gains over a period of time.
Exporters, be aware
For UK exporters, the question firmly at the forefront of minds is whether to buy sterling at these levels or wait to see if the pound falls further. Given how much sterling has depreciated, it means that any currency affected income is more valuable based on rates not seen for more than a year with respect to the Euro and two years for the US dollar.
With this in mind, UK exporters should carefully consider all USD and EUR cash balances with a view to trading at these levels. Should the market move lower still then placing further trades will allow businesses to achieve a lower average rate.
Whilst the credit downgrade has certainly not helped the run on the pound, the move we have seen was already in full flow and there are many other reasons for Sterling weakness, such as quantitative easing, stagflation and disappointing economic data. Ultimately today’s downgrade drama is likely to make way for more tomorrow’s new saga in Euroland.
Matthew Clarke is a senior currency consultant at Global Reach Partners, an independent foreign exchange firm.
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