World First’s chief economist, Jeremy Cook, explains what the Federal Reserve’s interest rate rise could mean for UK SMEs in 2016 and why January is a good time to talk to your account manager.
Despite the pre-Christmas hoo-ha, it was almost impossible to miss the headlines generated by the Fed raising interest rates for the first time in over a decade. Higher interest rates in the US will probably spark a period of increased risk to UK SMEs due to currency volatility – something I believe the UK’s internationally minded SMEs are ill prepared for, particularly new SMEs that have only ever known ultra-low interest rates.
Worryingly, our own research* reveals that 70% of UK SMEs believe their business could be better prepared to deal with exchange rate volatility, with 46% saying having a currency strategy was equal on the priority list in 2015 alongside staff entertainment.
How can you make sure your business isn’t caught out?
In my view there are three golden rules when it comes to managing currency risk and implementing a currency strategy:
1. Set a budget rate. Decide on the price of the contract in question and then set up a budget rate so you can have known costs. From there, you can look to ensure these costs are covered. Budget levels can be protected via forward contracts at the time of setting the budget or at all points thereafter. A forward contract allows you to fix an exchange rate for a specific date or time period up to two years in advance, giving you 100% certainty of the rate which you’ll receive when it comes to payment.
2. Be clear in your objectives when hedging. Are you a risk averse company that is simply looking to protect a budget rate? Or are you happy to hang on in the hope of more favourable movements?
3. Consider how the hedge affects cashflow. Different trades will carry different levels of risk and you need to be clear on what implications exchange rate moves will have. Also consider whether you are paying a deposit or providing a credit line; hedging is flexible, so a strategy can easily be designed to suit your business’s cash flow requirements.
Moreover, it is not just the likely US rate rise causing volatility. Options market volatility is already heightened courtesy of fears over Chinese growth, the fight against ISIS and political issues not limited to the UK’s referendum on EU membership.
If moves in exchange rates are a risk to your business, get in touch with the World First team.