The European Central Bank and the Bank of England find themselves on different paths, but one thing remains the same: every action they take causes a ripple in their respective currencies. With this in mind, we look at how accountants, treasurers and financial professionals can best prepare.
Politically, Europe and Britain find themselves at loggerheads. But it’s not just their views on the European Union (EU) that differ. The two central banks – The European Central Bank (ECB) and the Bank of England (BoE) – also find themselves in almost mirror opposite situations.
The ECB, which has been navigating a period of quantitative easing (QE) to battle against low growth, unemployment and the burgeoning threat of deflation, has shown signs that it will pull back on the QE reigns and end its mass bond-buying program. The ECB’s policy had significantly strengthened the euro against the dollar, and any change to the program (despite being a long-term change) will undoubtedly see the currency weaken.
While the EU has pursued a monetary policy aimed at stimulating growth, the UK has, up until recently, enjoyed a period of sustained growth. However, with a weakened sterling, this is no longer the case. Despite coming in lower than anticipated this week, inflation is still above the BoE’s target and debate is raging as to whether interest rates should be changed imminently.
All this is starting to affect business. A recent Deloitte CFO survey shows that confidence among CFO’s across Europe is down and in the UK, the prospect of higher interest rates and a general tightening of monetary conditions is the third biggest risk to finance teams. For accountants, treasurers, and financial professionals responsible for budgeting and forecasting, uncertainty is clearly still the order of the day. Especially as the banks refrain from committing one way or the other.
In this environment, accountants need to ensure that they have reliable data in place for exchange rates – rates that are available and accurate every single day. Why? Because the actions of a central bank, the economic calendar, and black swan events don’t just affect a currency once. The effects can be felt weeks afterward. Take the recent comments from Mario Draghi who stated that the European Central Bank will discuss changing monetary policy in "autumn". This alone caused the euro to rise above $1.157 against the US dollar despite falling to almost $1.148 before the news. With an Autumn deadline approaching, the currency is definitely in for a bumpy ride.
With frequent spikes as the new normal, finance teams will also need to retrieve accurate data for a given currency pair to forecast costs, understand cash flow, and budget accordingly. It could be the difference between an end of quarter profit or loss. Today, accountants need not worry about sourcing these rates either, as trusted exchange rate APIs can be integrated directly into existing architecture, be it operating system or ERP systems and delivered via an automated feed.
Possessing accurate, timely rates is crucial, but firms need to also be aware that there are two exchange rates to choose from. There are market rates, which as the name suggest are determined by market forces. Then, there is the Central Bank exchange rates, which also account for market activity (alongside other factors) but are published independently. Both have their merits and finance teams will have to utilise both for different situations. Central Bank rates should be used in financial reporting, especially when a central bank has unique regulations. But to understand a firm’s risk or to price actual cross-border transactions, a true market price is required. For global corporates, an automated source that provides both sets of rates are best.
Reliable rates are just as important for the group treasurer too. In order to forecast, hedge appropriately, and make the best investment decisions, the treasury team needs to understand how one event can impact future rates as this will determine their future activity. This is where historical data and analysis comes in. While it’s hard to outline exactly what the ECB or the BoE will do in six months’ time – given the constantly changing economic and political conditions – firms can use data to make educated guesses and plan accordingly. For example, given the recent drop in inflation in the UK, it’s unlikely that interest rates will rise within the next year. By combining this knowledge, and analysis of how rates reacted in similar situations from the past, treasurers can make informed decisions when actioning their hedges.
Ultimately, there’s a lot still up in the air for the BoE and the ECB and both banks are keeping their cards close to their chests. Despite this, an unexpected speech or statement (such as the Deputy Governor of the Bank of England’s recent quote) can still send a currency into free fall. Financial professionals, therefore, need to keep one step ahead and utilize Central Bank rate data to make the best decisions possible in the shortest time frame.