The new government’s mini-budget last week proved to be anything but. Indeed, it was so dramatic that it has spooked financial markets and sent the pound to record lows against the dollar.

Money, by JD Mack

The pound fell after last week’s ‘mini-Budget’

Sterling recovered a little from its nadir today (Tuesday September 27) but still remains at lows not seen since the mid-1980s. An extended period of volatility looks certain and brings yet another headache for retailers and their customers alike, many of whom are already buckling under the cost-of-living crisis.

From buying to refinancing, we consider some of the implications of the pound’s plunge on the retail industry.

Hedging their bets

Retailers that have currency hedging in place – and not all do – will be best-placed to manage the impact of sterling’s weakness against the dollar, the currency used for the purchase of many goods, ranging from clothes to electricals.

Retail Economics chief executive Richard Lim says that “more sophisticated” retailers will be operating rolling hedges, which can be modified on a quarterly or even monthly basis. That provides tactical advantages. 

“[Rolling hedges] gives them the ability to build in price increases over a longer period, which is particularly important at the moment when you’re dealing with other rising costs”

Richard Lim, Retail Economics

Lim observes: “It gives them the ability to build in price increases [resulting from exchange rate impacts] over a longer period, which is particularly important at the moment when you’re dealing with other rising costs.”

It also allows them, he says, to look at re-engineering towards goods priced in other currencies if that makes sense, or to streamline ranges to focus on lines with the highest margins.

Retailers that are unhedged face yet another potentially once-in-a-lifetime set of circumstances that will test those businesses already facing challenging balance sheets and razor-thin margins.

Sourcing costs climb

The range of goods sourced from markets such as China and priced in US dollars means that the weakened pound in retailers’ pockets doesn’t go as far as it did.

How that will affect individual retailers will directly relate to what percentage of product they currently source from abroad in USD. 

One big name likely to be protected is Zara-owner Inditex, with its unique supply chain that includes sourcing from Europe. Other retailers cannot replicate Zara’s model, but may be able to move some sourcing closer to home – although the pound has been falling against the euro also.

One industry source says the magnitude of the events of the past few days means some retailers are unsure of exactly what the hit might be on their buying power, and they are scrambling to work out what options are open to them.

Some retailers will be protected to some degree, however, having forward-bought goods.

Another blow for consumers

Consumer confidence was already at an all-time low before the pound crashed. Needless to say this only further erodes consumer sentiment and undermines spending power.

Now the likelihood of a further Bank of England interest rate rise – on top of the half a percentage point to 2.25% last week – and perhaps reaching as high as 6% in coming months, adds to an already worrying list of issues facing the sector, alongside steep inflation in non-discretionary categories such as food and soaring energy costs. 

Aldi Local Balham

Aldi said it would ‘double down’ on low prices despite lower profits in the last year

On Monday (September 26) mortgage providers Virgin Money, Skipton Building Society and Halifax temporarily withdrew products for new customers – a move that is hardly going to shore up confidence in the housing market. It won’t help retailers in categories such as furniture and homewares either, where new home ownership is frequently a driver of sales.

“The big shift in sentiment is expectations of higher interest rates,” says Lim. He estimates about 20% of mortgages may be up for remortgaging over the next 12 months, when people could be looking at an increase from around 1.5% to in excess of 5% in their monthly payments. 

Retailers with the financial firepower to keep prices low will be in a strong position. Aldi maintained that it would “double down” on low prices, despite that contributing to lower profits in the last financial year. Value fashion giant Primark also said it would not increase prices any further, also at the cost of profits.

Overseas visitors can splash out

If there is one silver lining to the febrile situation, it is that overseas visitors from places such as the US will find their money goes further when holidaying in the UK.

Last week’s mini-budget also included the reinstatement of VAT-free shopping for overseas visitors – something that retailers increasingly have been asking for. A return of visitors with plenty of money will be good news for locations such as London’s West End, which was hit hard by the pandemic and its aftermath.

“[VAT-free shopping will] breathe new life into sectors which were particularly hard-hit by the pandemic, and restore this country’s position as one of the world’s leading tourist destinations”

James Lambert, Value Retail

The move will also likely prove to be a boon for the luxury retail market. Deputy chairman of Bicester Village-owner Value Retail James Lambert said the announcement would “breathe new life into sectors which were particularly hard-hit by the pandemic, and restore this country’s position as one of the world’s leading tourist destinations.” 

UK retailers become more attractive M&A targets

Overseas buyers are likely to take greater interest in acquiring UK businesses because sterling’s fall means purchase prices represent bargains.

Whether distress sales or trophy assets, the slide-rule will be cast over British retailers by dollar-rich potential buyers.

Over the past few years, giants such as Asda and Morrisons have been snapped up by private equity buyers – might the pound’s weakness prompt a new flurry of deals? Some retailers such as Made.com, already creaking under the strains of a tough environment, have put themselves up for sale and may draw more interest if they can be bought on advantageous terms.

Geographical spread mitigates risk

JD Sports

JD Sports, with a successful US operation, will benefit from dollar-denominated revenues

Retailers with an international presence – especially in the US – will be better insulated from the effects of sterling’s fall than some of their UK-only peers.

Businesses such as Zara and JD Sports, with successful US operations, will benefit from dollar-denominated revenues which will minimise any pain felt at the UK operations.

“The main point is it [international presence] spreads risk,” says Lim. “In the UK you’re facing all the impacts in an isolated market.”

Financial restructuring will accelerate

The pressures heralded by a weaker pound will prompt a wave of action to strengthen balance sheets, such as debt restructuring by financially troubled and healthy retailers alike. Like consumers, some retailers will feel the pain of higher interest rates.

Retailers saddled with high borrowings, such as some of those acquired in debt-financed deals, are likely to review financing arrangements. 

Lim says: “Even before the mini-budget, I think the levels of distress were rising because of the weaker consumer outlook.

“A lot of retailers will be pulling forward debt restructuring where they can to manage costs.”

More generally, he says, retailers will be stress-testing their financial positions to see how much “stretch” is available to them in tougher times.

After such a badly received mini-budget, the hope is that more clarity will be provided when chancellor Kwasi Kwarteng unveils a ‘medium-term fiscal plan’ in late November. Until then – at least – expect continued volatility and a sluggish pound.

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