Following a tumultuous 21 months, October saw UK inflation rates soar to 4.2% – a 10-year high, and a far cry from the Bank of England’s target of 2%.
The Financial Times reports that the surge in inflation – or unusually high prices – is “leaving the world’s leading economies with their lowest real interest rates in decades, as central banks delay any abrupt tightening of the extra-loose monetary policy used to help weather the coronavirus crisis, arguing that the recent rise in prices is transitory.”
Put simply, prices are high because there isn’t enough supply to accommodate consumer demand.
High inflation may help governments finance the debts they took on during the pandemic, but it is also said that negative rates “could cause already richly valued financial markets to become exceedingly unsustainable, causing concerns about financial stability risks.”
Why is inflation linked to exchange rate volatility?
Well, one reason is that inflation across global economies tends to lead to spikes in exchange rate volatility, which ultimately reduces the value of currencies in countries experiencing the highest inflation. For example, a higher inflation rate in the UK compared to other European countries would reduce the value of GBP because this makes UK goods increase in price quicker than European goods. This makes UK goods more expensive and less competitive.
When prices rise, it doesn’t just affect consumers. Inflationary pressures, whether they are to be temporary or more permanent, will hit UK corporates in the coming months. When combining all the challenges that businesses have had to handle over the last 21 months, it seems like another obstacle on the way to recovery.
Businesses will end up paying more to buy materials and products, leaving them in a difficult position; simply raising product prices is not a flawless option, as this can make products and services unaffordable for customers. Yet at the same time, businesses are needing to pay more for increased material and manufacturing costs, and also make enough money to support a higher cost of living. SMEs in particular may be particularly susceptible to these rising costs. Philip Stephens, Head of UK Corporate FX Dealing at Moneycorp says:
“Inflationary pressures whether they are to be transitory or more permanent will hit UK corporates in the coming months. When combining all the challenges that businesses have had to handle over the last 18 months it seems like another obstacle on the way to recovery. SMEs may find it tougher to absorb the higher costs than larger corporates who can pass on some of the costs as the Christmas squeeze takes hold. In our world of FX, with markets reacting to data and headlines the addition of corporate margins coming under pressure from higher input costs means it becomes more and more important to manage your currency risk as efficiently as possible. Please reach out if you need our help.”
Greater variation in the economy also disproportionately impacts industries that see more volatility, like construction, business capital goods and consumer durables. At the other end of the range are relatively stable industries, like healthcare, which aren’t as significantly impacted by fluctuations in the economy.
How can stability be regained?
Central bank policy is one way. Most modern central banks base monetary policy on the country’s rate of inflation. If prices rise faster than their target, central banks compensate by increasing interest rates. In fact, Poland and the Czech Republic recently made aggressive raises to interest rates, alongside Russia, Mexico and Brazil.
Furthermore, rising inflation rates do not always mean other changes – such as increased interest rates – will follow. In our world of international payments, with markets reacting to data and the addition of corporate margins coming under pressure from higher input costs, it is increasingly important to manage your currency risk as efficiently as possible.
Key considerations for SMEs include:
- Monitoring the government’s discussion on monetary support for small businesses. This is currently underway, so it’s important that SMEs pay close attention to shifts in monetary policy in the coming weeks
- Consulting a specialist international payments partner to help understand your risk and address the knock-on effects of the pandemic on supply chains, inflation and the value of UK products in the global economy
Amidst so much uncertainty, by taking these steps, SMEs can limit risk and navigate the various scenarios that could unfold in the coming months.