International Finance

EU woes raise concerns of currency volatility

Is the fallout of developments in Spain, Greece, Italy

While Sterling has been a weakened currency of Europe since the June 2016 vote in favour of Brexit, a series of unfortunate events now raise questions over the stability of the Euro in the weeks and months ahead. The constitutional pain of Spain, along with the unfolding Greek and Italian tragedies, not to mention the rise of the German right all present real challenges for the single currency going forward.

The events in Spain, following the Catalan government’s decision to stage an illegitimate referendum on independence and the reaction by the national government, is a concern for both the European economy and the wider international community.

This vote also had a direct impact on the Euro, which fell by 0.6 per cent against the dollar to approximately $1.174, one of its lowest levels since mid-August. Market analysts, who predicted at this point that the referendum would likely start a new phase of political instability for the EU, have so far been proved right.
After making a small recovery, the Euro once again fell against the dollar when the Catalan regional assembly voted to leave Spain after the national government declared the referendum result null and void.

The events which followed, with the arrest of politicians and activists on charges of sedition and rebellion along with the self-imposed exile of Catalonia’s regional president Carles Puigdemont, have been more akin to the actions of a Third World dictatorship than a country which is a full-fledged member of the European Union. They are unlikely to help promote confidence in Spain within the international business community. Governments across the EU will now be hoping the snap election to be held in Catalonia on December 21 will restore stability to the region and the rest of Spain.

Another crisis in the background
The events in Spain have also served to put two other key issues, namely Greece and Italy, on the back-burner for now. Both countries have failed to meet fiscal reforms and austerity measures, all of which has real potential to trigger a serious economic crisis throughout the Euro-zone. Despite their predicament, both countries have managed to get funds, saving them from defaulting, but this situation is not viable in the longer run.

Italian banks are facing a crisis similar with around $400 billion in bad loans on their balance sheets. The country’s weak growth is making it difficult to address the problem. Meanwhile, Greece’s economy has never really recovered from its well-publicised debt crisis, which initially came to the fore in 2011 when European Union leaders agreed to a substantial bail-out package. Questions still linger as to whether Greece may still have to leave the single currency to free it from its current cycle of unmanageable debt.

Other worrying factors
All these factors as well as the right wing AfD’s surprisingly strong results in September’s German elections raise questions about the EU’s stability going forward. There is potential for it to impact on the value of the Euro, which would create wider global implications.

British manufacturing exports into the EU have recently soared on the back of a low pound, but a sustained fall in the Euro could threaten that. UK exports to Spain are relatively small, but the impact of business within bigger Euro-zone markets, like Germany and France, would be a huge concern.

The UK’s tourism sector, which had enjoyed a post-Brexit boost in 2016, is also at risk with a falling Euro. Last year, 25.3 million EU visitors came to the UK, up four per cent on 2015, a rise which was partly attributed to a strong single currency against the pound.

A fall in the Euro could, of course, help some British companies which currently buy goods and services in the EU or have employees based there.

Whether they stand to gain or lose from the developments across the EU, all British companies which export to or import from this market should be putting measures in place to minimise their exposure to potential foreign currency movements.

Implementing a robust and comprehensive risk-management strategy is now more essential than ever. Businesses need to look at how they can best conduct their transfers strategically to manage their exposure and secure profitability. The starting point is to clearly understand their level of exposure to currency movement and then to set out an appropriate budget rate and create a suitable hedging plan.
Using a combination of forward contracts, spot deals and orders according to such a strategy can provide certainty and protection, shielding their bottom line and maximising the funds they receive.

These developments across the EU, which earlier in the summer seemed to be confident and on the front foot economically, underline how quickly circumstances can change. While it is hoped that stability will soon be restored in Spain, businesses in the UK must ensure they are not exposed to these risks, which can significantly impact their profitability.

Daniel Stanley is an Option Trader at London-based foreign exchange specialists Global Reach Partners

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