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Taking a pounding - how the exchange rate affects us all

Taking a pounding - how the exchange rate affects us all

The value of the UK pound has fallen dramatically in the last six months, against most currencies, most noticeably the US dollar and the euro.

Those of you that have been abroad in the last few months will have already noticed an unwelcome difference to your spending power. In this Sense piece we’re going to look at other likely effects too. We’re calling it Taking A Pounding.

The pound was perceived to be over-valued for some time. The correction that many analysts anticipated has hit even harder. The perilous state of the UK economy has led to investors selling sterling to invest elsewhere. There are three main reasons for this:

The UK’s economic prosperity is very dependant on its financial services sector, which is currently suffering from a lack of confidence and trust; UK has a large debt in comparison to many Eurozone economies; reduced interest rates mean lower ROI on money invested in British banks.

The exchange rates have moved to such an extent that goods worth $100, which 12 months ago would have cost £50 to import, now cost £70. Likewise the €100,000 dream villa in Spain that cost around £71,000 little over a year ago, now costs £20,000 more, solely due to fall in the value of sterling.

You may recall that in the late 80s, the government raised interest rates to 15%, in an attempt to encourage investors to buy sterling, and prop up the troubled currency.

Nowadays, the Bank of England is more independent. It sets the interest rates, and does so primarily to control inflation (increasing rates) and stimulate growth (lowering rates), rather than to prevent devaluation of the pound.

It’s difficult to find anyone who’s predicting that the pound will recover in value to
anything approaching $2 or €1.4 (its peaks in 2007/2008). So what does this mean for consumers and businesses in the UK?

For holidaymakers travelling abroad, it means prices going up. Tour operators, like most businesses, plan and buy their stock well in advance. They also hedge to counter any negative effects from currency and oil price movements. This means we may not see package holiday prices increase for a while, but they will increase. Of course, many foreign holiday costs – eating out, drinking, entertainment and excursions – have already effectively increased in price.

Over a third of Britons expect to be holiday in Europe less this year than last 1. Petrol prices have already begun to rise again, by 4.3p/litre in January, despite the dramatic drop in the price of oil (after an equally dramatic increase last year).

Oil, is of course, traded in dollars. The North Sea oil has passed its peak levels of production, and the UK is a net importer of crude oil for the first time in decades, leaving us more exposed to price fluctuations. We’ll also see further price increases for other raw materials and part-assembled goods.

In late March 2009, the UK’s consumer prices index (CPI – essentially inflation rate, discounting housing costs) rose to 3.2% from 3.0%. This rise surprised many analysts. It was driven by another increase in the price of fruit and vegetables – products imported from abroad, particularly during winter. Overall, however, sustained deflation remains a worrying prospect.

When this occurs, consumers usually delay purchases, holding onto their money, further harming the economy. New car sales are down almost 30%2 and people continue to delay major purchases3. There are, however, plus sides to the pound’s weakness. Goods manufactured in the UK become cheaper to export.

The UK exports 60% of what it produces to the Eurozone, so this is no mere consolation. Foreign visitors are finding the UK cheaper to visit than for years, giving a boost to the UK’s tourist industry. 36% of the visitors to the London’s Southbank Christmas Frost Fair were from abroad, up from 20% the previous year4.

We’re also seeing an influx of foreign property investors, potentially giving the housing market a kick-start. It seems like a great time for brands to talk about their British credentials and heritage.

Consumers will soon learn that they’re paying more for imported goods, and that by buying British, be it holidays, groceries or manufactured goods, they can get better value, and stimulate the economy. ‘Foreign’ brands that can hold off increasing their prices, or find ways to combine price rises with increased value will be favoured by cash-strapped consumers.

Sources: 1 – OMD Snapshots 1009 UK adults; 2 – ACEA; 3 – GfK NOP ‘Climate for major purchases’; 4 – Better Bankside.

By Ben Haley, Insight Director, Manning Gottlieb OMD


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