Economic environment: Exchange Rates

Data from Timetric.To view this graph, please install Adobe Flash Player. Broad sterling effective exchange rate index Jan 2005=100, monthly from Timetric

No AS/A2 Business answer with an overseas dimension is complete without mentioning exchange rate change. Here’s a brief guide, and some accompanying links and issues.

The exchange rate is the price of a currency. That’s often a very difficult concept to get your head around, particularly as ‘common sense’ is misinformed by “exchanging” or “swapping” currencies when you go abroad on holiday. But if you get some Euros before heading off for France, you aren’t swapping your £s for €s. You’re buying them.

So the £ is quite literally on sale in the foreign exchange market. The graph above points out the basic history you need to understand. The £ broadly fell in value (it ‘depreciated’) from the 1980s until the early 90s. Our currency then sharply appreciated in the mid 90s, where it stayed (with some fluctuations) before plunging again in 2008.

What does this mean for UK businesses?

- In general, a lower value £ means that imports are more expensive. That’s part of the reason why there’s been upward pressure on inflation recently. Anything that comes from abroad is now more expensive: parts, components, finished goods, stocks, oil, food. Almost all firms import something, and are therefore likely to face higher costs. UK customers may move away from imports and foreign holidays as they are relatively more expensive.
- That leads to a wider benefit: the UK is now relatively cheaper to foreigners, providing UK firms with better export opportunities, as well as more domestic demand. See an end to Outsourcing?

Evaluation points

- The impact of changing exchange rates will be different on different businesses. Firms with big import bills will be hit hard. Other businesses that are seeking to expand exports may find demand increasing for their products or services. Firms that were planning to ‘offshore’ some of their production might reconsider (check out the links below).
- The uncertainty of exchange rate change is a big headache for firms, and tends to undermine overseas investments and makes UK firms think twice before embarking on any overseas project.
- Exchange rates might not make such a big difference if firms or their customers are not price sensitive, of course.

A few links from 2009 when £ really dived:

Falling Sterling keeps the stags at home
Tesco Ireland and the impact of changing exchange rates
Will outsourcing slow as the £ falls in value?