London: UK. Plc is losing its battle against the forces of inflation that have been bearing down since the Brexit vote in June.
As the pound plumbs record lows on a trade-weighted basis — driving up the cost of imports like South African blueberries and Italian bathroom fixtures — the cost to hedge against further currency declines is soaring. The dilemma for merchants: pass on that cost or hold the line on prices that erode profits.
Take Sofia Charalambous, who sells faucets, mirrors and soap dishes at her Romford, England-based retailer, Bathroom Origins. The £50,000 (Dh223,800, $61,500) of euros that she bought via currency forward contracts before the UK decided to leave the European Union have been exhausted. Now she needs to pay French, Italian and Spanish suppliers in pounds that are worth 15 per cent less against the euro, and she’s preparing to raise prices.
“We’re in a difficult situation because we don’t know where to price the pound,” says Charalambous. “We don’t have a clue what’s going on.”
It’s not just small businesses like Bathroom Origins, with about £1 million in annual sales, that have gotten caught out by the pound’s post-Brexit plunge. Athletic-goods chain Sports Direct International Plc said last week that losses on its currency hedges after a “flash crash” in the pound could cut earnings by as much as £35 million. Exchange-rate movements cost UK-based airline easyJet Plc about £90 million in the year that ended September 30.
Four-fifths of the U.K.’s 1,000 most valuable companies, along with 22 per cent of small and medium-size firms, put currency protection in place in the run-up to the Brexit vote, according to research firm East & Partners. Now that many of those hedges are rolling off, the UK economy could be in for a dose of inflation.
“There may well have been some degree of sheltering of the impact, but that sheltering is merely marking time,” said Jeremy Stretch, head of foreign-exchange strategy at Canadian Imperial Bank of Commerce in London. “It may be that it’s early next year when we start to see the collective pain starting to be felt.”
The pound has fallen against 31 major peers since the Brexit vote, with the currency set for its steepest annual decline since the 2008 financial crisis. Losses have accelerated this month amid concern that Prime Minister Theresa May will risk access to the EU’s single market to secure greater control over immigration. The pound regained some ground Wednesday when she said she’d let Parliament debate the government’s plans for leaving the bloc.
The pound flash crash
It costs the most since the end of July to buy options protecting against a weaker pound, when compared with those that hedge against sterling strength. The three-month risk-reversal rate widened to minus 2.04 percentage points Tuesday.
A 20 per cent fall in the pound could cause import prices in the UK to rise about 12 per cent to 13 per cent and could lift consumer prices by an extra 4 percentage points over three or four years, Bank of England Monetary Policy Committee member Michael Saunders said.
The central bank forecasts that consumer prices will rise 2.1 per cent in 2017, up from 1.3 per cent this year.
UK exporters and companies that generate significant sales overseas have benefited from the currency’s plunge, which makes their prices more competitive and translates into higher earnings when converted into pounds. Charalambous said her business got a boost from favourable hedges in the first half of the year, tiding it over now that rates have swung against her.
For businesses with costs denominated in other currencies, the challenges are greater. UK retailers, for example, buy large quantities of food from continental Europe and typically hedge on a rolling basis, meaning they’ll face higher costs next year.
“Past Christmas is when the inflationary pressure will be felt,” said Judith Batchelar, director of the flagship brand of grocer J Sainsbury Plc.
Companies with more elastic costs and flexible pricing have reacted already. Tropical Sky, a UK travel agent, used to hedge for three or four months at a time to protect itself against changes in costs for overseas destinations. Now it’s “pretty much buying dollars on a weekly basis and adjusting prices, financial director Jacqui Collins said.
“We don’t necessarily lose a profit on the booking — but we might lose the booking, because we’ve had to increase the selling price,” she said.
As the pound falls further and volatility increases, the cost of exchange-rate protection is rising. Sports Direct succumbed to what it described as “extreme movements” in the pound, pushing it below a level that nullified hedges put in place after the Brexit referendum.
“Lots of corporates hedged the potential of a Brexit, but they had short-term hedges in place and many of those are coming to an end now and when they look to reset them they’re really expensive,” James Garvey, head of capital markets at Lloyds Bank, said Wednesday at a conference at Bloomberg in London.
Collins said she previously used leveraged contracts to try to take advantage of favourable swings in exchange rates, but she’s gotten more cautious since the vote raised the risks.
“In some cases, there are almost more dangers to hedging than there are to not hedging,” said Richard de Meo, founder of foreign-exchange provider Foenix Partners in London. “It’s very challenging for companies who have wanted to be disciplined.”