Understanding the effects of the exchange rates on businesses

While the coronavirus pandemic has broadly had a damaging impact on business and the world’s socio-economic climate, it has also fostered a wave of innovation in the entrepreneurial realm.

However, it’s important to note that in addition to coping with the impact of Covid-19, business owners are also trying to factor in universal macroeconomic factors such as interest rates and inflation.

Exchange rates also have a considerable impact on businesses, especially those who trade in international markets. We’ll explore this in further detail in the article below.

What is the Exchange Rate?

In general terms, an exchange rate is defined as the value of one nation’s currency measured against that of another country or economic zone (such as the EU).

While exchange rates have historically been tethered to the value of gold or the US dollar, today’s entities are free-floating and rise or fall freely based on the basic principles of supply and demand.

As a result, modern exchange rates can fluctuate wildly within a relatively short period of time, with these presented in real-time through forex brokerage sites and monitored almost constantly by foreign exchange traders.

The Practical Impact of the Exchange Rate on Businesses

While this should afford you an insight into the premise of exchange rates and their movements, the question that remains is how they impact on the day-to-day operations of businesses.

To understand this, let’s consider a scenario where the pound has depreciated sharply against the Euro, impacting on firms that sell into the single bloc and also source their raw materials from EU nations.

In this instance, the depreciation of the pound will automatically make exports cheaper, as the buying power of the Euro in comparison with the GBP increases noticeably. So long as the GBP/EUR pairing continues to trade in a narrow range (which is typical for this asset), this will create more competitively priced exports that benefits UK firms.

Of course, this scenario could change if the pound was to plummet against the Euro (as happened after the referendum vote in 2016), as this would completely devalue exports and force businesses to potentially incur losses.

In the same scenario where the pound falls marginally against the Euro, however, firms importing raw materials will face considerably higher import costs. This is because it will cost more pounds to procure materials from countries where the Euro holds a higher value, impacting directly on manufacturing costs and eating into profit margins in the process.

What Happens When the Pound Appreciates?

Recently, investors will have noticed that the GBP/EUR pair has soared to 10-month highs, with the single currency struggling against the backdrop of a failed vaccine rollout and wider economic decline. 

So, what happens to UK businesses trading with Europe in this instance? In simple terms, the scenario outlined above reverses, as exports become more expensive while the cost of raw materials from the single bloc (such as oil) depreciate.

This will typically diminish revenues generated through exports as customers seek out more affordable alternatives from other global suppliers, although those that also source their materials from EU nations will be able to minimise losses simply by reducing procurement costs.

Ultimately, the impact of changing exchange rates depends on the precise movement of specific pairings and the nature of your business, particularly in terms of where you sell and how you source raw materials.

This is why it’s so important that you monitor exchange rate and currency price movements in real-time, while ideally using analytical tools to forecast future changes and adjust your business strategy as a result.

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