Managing currency volatility to boost profitability

With wholesalers still facing unprecedented business uncertainty and volatility, it has never been more crucial to focus on key drivers of profit margins such as currency costs. And the third quarter of the year presents particular challenges for the sector. With the buying season for Black Friday and Christmas in full swing, invoices are falling due. The ability to manage foreign exchange risk at this time of year may be the difference between a profitable peak season and a slide into the red.

Reasons for optimism

The good news for the wholesale trade is that significant sectors of the retail industry have held up well during the coronavirus pandemic. Over the three months to July, food sales increased 8.2% on a like-for-like basis compared to the second quarter of 2019 – the best figures since 2009. Non-food retail sales rose 7.9%.

The headline figures mask some significant variations. For example, the home improvements sub-sector has performed particularly strongly in recent months, but clothing and footwear has found the going much tougher.

Online sales have been a bright spot, with the shift to e-commerce accelerated during lockdown and continuing to endure. Online sales rose 54% year-on-year in July according to Retail Economics, accounting for 28% of total retail sales that month.

In-store trade, by contrast, has continued to suffer at the hands of coronavirus, though the data is beginning to look a little brighter. Footfall improved week-on-week during August, particularly in retail parks, though shopping centres and high streets remain much quieter than last year.

Other data supports the idea that consumers are feeling more positive. Visa points out that while consumer spending has continued to be lower than in 2019, the decline has slowed in recent months. GfK’s monthly survey of consumer confidence suggests pessimism has dissipated since the height of the pandemic in March and April, with Britons feeling less anxious about both the state of the economy and their personal financial circumstances.

Confronting currency risk

Nevertheless, the trading environment for wholesalers remains fraught with risk, particularly given the potential for a second wave of coronavirus that could impact the recovery. In this context, the elevated level of foreign exchange market volatility during the turmoil of recent months presents a particular headache.

Assessing the impact of the pandemic on the currency markets at any given moment is challenging, given how rapidly sentiment in different regions and countries can change in the context of the pandemic. However, throughout this period, sterling has traded in a wider-than-usual range against world currencies including the dollar, the euro and the yen. The pound fell sharply against each of those currencies in the spring, but has since staged something of a recovery.

The Brexit negotiations provide added complexities. It’s notable that sterling’s recovery against the euro since the summer has been much more modest. Making predictions about the outcome of Brexit remains as difficult as ever, with the UK and the European Union still at loggerheads over the detail of our future trading relationship.

For wholesalers with exposure to imports and exports, picking a path through these uncertainties is challenging. International trade continues to offer UK wholesalers exciting opportunities, both as a source of products for domestic sales and as a generator of overseas sales revenues. However, the profitability of such trade can be undermined by an unanticipated move in foreign exchange rates.

The cost of imported goods, in sterling terms, may be higher than expected if the pound loses value. An appreciating currency, meanwhile, may represent an opportunity to lean more heavily on imports. On sales, a falling pound will boost the value of overseas sales, but a rise in sterling is potentially damaging to margins.

These concerns represent a potential impediment to growth. Businesses will be keen to end the year strongly, capitalising on what will hopefully be a continued improvement in consumer confidence, in order to bounce back from the difficulties of earlier in the year. But their ambitions may be tempered by nervousness about the impact of currency market volatility on profitability.  

With so much at stake during the final few months of the year, it’s vital that wholesalers weigh these issues carefully. Working with their bank and advisers, it’s possible to hedge currency market risk using financial products and services. For example, forward contracts provide a means with which to fix foreign exchange rates, providing certainty about import and export costs and revenues. Bought options contracts provide certainty against adverse currency movements but potentially enable wholesalers to benefit if rates move in their favour. 

Importantly, however, these solutions carry their own costs and risks and there are no one-size-fits-all options. Wholesalers will usually need specialist advice to pick the right solutions for their businesses, mitigating currency risk in a way that reflects the profile of their international exposures.

• Listen to the webinar in full, hosted by John Carroll (Head of International & Transactional Banking, Santander) with speakers Stuart Bennett (FX Strategist, Banco Santander S.A London Branch), Nathan Hutchings (Head of Risk Solutions, Santander), Sukh Nat (Head of Wholesale & Retail, Santander) and Richard Lim (CEO, Retail Economics). Listen to the webinar.