Opinion
1 Mar 2013 08:37am

The aftermath of the downgrade

We knew it was coming. Rumours of a downgrade were rife. Amid all the speculation, the pound had been part of the ‘Markets saga’ for weeks, having depreciated by 8% against the US dollar since December 2012 and 11.5% versus the euro since October last year.

So it was hardly a bolt from the blue when Moody’s announced that Britain had fallen out of the Triple AAA club and had been downgraded to Aa1.

Headlines in the media this week have been quick on the offensive about  the 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". But what does it really mean for the markets and, more importantly, how will this impact UK businesses?

Politicians (or at least those rallying around the chancellor) and analysts have been quick to call the downgrade largely symbolic, which is a fair point.

While downgrade may sound dramatic, both US and France had lost their AAA rating in 2011 and 2012 and bounced back without any major impact

While downgrades may sound dramatic, both US and France had lost their AAA rating in 2011 and 2012 and bounced back without any major impact on their ability to borrow on global markets at very low rates. Given the speculation it is most likely that the UK downgrade was fully priced in, so the balance of probability suggests exchange rates could bounce higher from here as markets are very fickle.

The US and Europe still face significant headwinds including the re-emergence of issues surrounding the US fiscal cliff and the resolution of the Italian government.

UK debt is among the world’s most stable and though net debt has risen in recent years at 66.6% of GDP, it remains way below levels seen during the last 300 years. This is below the US and much lower than EU’s maximum targets of 80%, so Britain should always be regarded as a good credit risk.

British government bonds earlier this week were stable, with the 10 year rates edging up only 0.016 of a percentage point to 2.13%. It suggests investors remain confident that the UK will be able to manage its debt long term.

But how will UK exporters and importers now fare?

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.

For UK importers, this is clearly bad news. Previous support levels have been broken and any indication of a recovery of sterling is slowly diminishing. The key from here is not to try and chase the market higher, but look in detail about what short and medium term exposures look like and the impact that further lower movements may have.

Despite now seeing exchange rates that in many cases below budgeted levels, the important thing now is to stem any further loss, re-group and work back losses over a period of time. This also further highlights the need for a detailed FX strategy rather than a reactive spot policy.

While it may be months before the pound regains its dignity in the markets, the chancellor may restore faith amongst UK businesses sooner.

Let’s hope that Budget day will herald some much needed measures to help kick-start growth for UK businesses trading overseas.


 David Huggett is a senior currency consultant at Global Reach Partners


 

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