Pound to Euro Decline Creates Headache for Unhedged CFOs, Bank of England Unable to Halt Declines

The sharp decline in the pound to euro exchange rate (GBPEUR) over the past 7 weeks has seen many corporates caught unguarded in their currency exposure needs.

Stress as the pound to euro moves against corporates

At the time of writing the GBPEUR is sitting above support at 1.32 with some analysts suggesting that should this level giveway then a breach below 1.30 then becomes a realistic prospect.

Remember when the British pound could buy you more than 1.40 euros?

Those that were holding out for ever-higher conversions will rue the lost chance of converting above 1.40:

“The sharp fall in the value of the Pound against the Euro since the beginning of December has caught a number of corporates off-guard, with many failing to take advantage of the GBP/EUR exchange rate whilst it was above 1.40,” says Andy Scott, economist at HiFX.

HiFX are one of the UK’s largest currency brokers and work with corporates to hedge against adverse moves in the currency markets.

“We’re talking here of course about companies that import goods or services from our largest trading partner – the Eurozone. Whether it’s food products from Italy or manufactured components from Germany, UK business have large exposures to the value of sterling versus the Euro,” says Scott.

Annual imports totalled approximately £280bn in 2014 according to the ONS.

Scott notes that the majority of his clients did have suitable hedging strategies in place to help mitigate the risk to their profits from a fall in the value of the sterling to euro exchange rate.

However, “we’ve received a number of calls over the past few weeks from nervous business owners and CFO’s who remain exposed,” says Scott.

The overwhelming reason given for them not having hedged their risk by purchasing Euros needed in the months ahead through a forward contract for example, was a number of banks forecasts for the Euro to weaken further in 2016.
The difficulty they now face is that the GBP to EUR exchange rate is at its lowest for nearly a year, and 7% lower than it was just a month ago when some of these companies were setting FX budget rates for the current year.

“The conversations we’re having are focused on the need to revise the budget rates to reflect the move in the exchange rate and trying to encourage companies to implement an FX policy that sets out hedging parameters, to avoid being under hedged and exposed to such volatility in the future,” says Scott.
Sterling’s fall against the Euro has been aggressive and largely due to sterling weakness as growth has slowed slightly and inflation remained low, allowing the Bank of England to remain on hold with interest rates for longer.

“If the market takes a more upbeat view for the Euro, we could see a move down to a more neutral valuation between 1.25-1.2850 in the weeks ahead,” says Scott.

Sterling Attempts to Recover in Wake of Bank of England Event

It is hard to back the British pound in the current risk-off environment. Correlation studies show that the GBP-EUR is falling in sympathy with the FTSE 100.

But, there are some slivers of hope available for those waiting on a stronger exchange rate.

Sterling is off recent lows agains the US dollar and euro following the release of the January Bank of England policy decision

As expected, the Bank of England’s policy decision (0.50%, £375bn) and vote (8-1) remained unchanged today, to the disappointment of some in the market who had anticipated a step-down by Ian McCafferty.

With no change to the outcome, attention quickly shifted to the minutes, which painted a slightly more balanced tone than some  were expecting.

“Today’s minutes signalled the MPC are more sanguine about the outlook for the UK economy than the market was expecting and may provide some respite for sterling in the days ahead," says Scott.

Nevertheless, momentum is pitted against sterling at present and whether or not an inactive Bank of England can provide support in the current market remains doubtful.

Be prepared for further downside.