No-one could deny the euro’s first quarter has been troublesome and certainly less glamorous than the first week of euphoria, but has the fledgling currency really been the damp squib that some commentators have suggested?
And, if confidence has been damaged by the euro’s slower-than-hoped-for progress to date, should UK corporates still embrace the new currency as part of their business planning?
The euro’s ailments fall into two distinct categories: those that result from structural and performance differences between member countries’ economies and those derived from global events and macro-economic trends.
The structural differences of each euro country were apparent well before the euro’s launch. To believe in the euro, you must contend that the new currency can hold its own within existing conditions and that it will gain operational strength with each step taken towards closer economic integration. From this perspective, the euro’s progress to date has been blunted not so much by in-built inadequacies as by a mixture of economic misfortune and over-hyped expectations.
There is certainly internal pressure on the euro – currently from Germany and France. Germany, the largest economy in euroland, is putting in a weak economic performance and struggling with high unemployment. For the Germans, long the victims of a zig-zag economic policy and still unable to grasp the nettle of tax reform, spurring growth through a domestic reduction in interest rates is no longer an option. On the other hand, lowering the rate across euroland would arguably prompt inflationary pressure in Spain and Ireland – currently still enjoying economic growth well over the euro-zone average.
France too is feeling the heat; the inflexibility of its labour market is a serious impediment to the growth of employment. The single currency and a single interest rate will contribute towards the pressures for economic change.
We should not be surprised or alarmed by differences of this nature.
The positive outlook for their gradual reconciliation was factored into the new currency at a very early stage of planning. The convergence of individual countries’ economic cycles was never going to happen overnight.
(Ironically, on the outside, looking in, the UK economic cycle now seems to be moving towards closer alignment with the rest of Europe.)
We must look farther afield for the factors that have really hampered the euro’s progress. The stronger-than-expected performance of the US economy at a time when the consensus was for a slowdown or worse has taken most of us by surprise. While the major European economies are cooling – the UK is no exception – the US continues to steam ahead. There is no denying that the new currency has lost 10% of its value against the dollar since its launch – but 75% of this slippage can probably be attributed to sustained US growth.
Whether or not you accept this, beneath the macro-economic umbrella, business life goes on. The euro’s integration within the financial markets and within general corporate activity may not have been as meteoric as some had hoped for, but there has certainly been progress.
At Barclays, we have seen a growing number of corporates tapping the eurobond market. Many corporates have taken the opportunity to tap the investor demand and, in many cases, have issued their debut issues. In addition, a large number of companies, many of them smaller than the bond market would usually accept – or with lower credit ratings – are starting to tap the bond markets and are increasingly expected to raise capital in euros. From an investment perspective, the need for higher yields has seen many European investors diversifying from government bonds into credit bonds as the latter have offered a more attractive rate of return.
Banks are only part of the total picture – our infrastructure may work, but without a throughput of business, it is redundant. Acceptance of the euro is a customer-driven process and it is our customers that we look to for a clearer indication of what they need on the ground.
The euro with its same-day wholesale payment systems – TARGET and EBA to name but two – has enabled companies to look more closely at their cash management and treasury structures and the costs involved.
Some corporates have already taken advantage of this opportunity. The clear trend is towards centralisation to establish European sweeping and pooling structures enabling surplus funds to be swept into a single euro account on a daily, weekly or monthly basis.
Changes to payment and collection services, such as reduction of the number of banking contacts and the shift from bank lending to the capital markets, have been slower than originally anticipated, but will undoubtedly form the next stage of restructuring for European multinationals.
We have set ourselves the task of helping corporates make the most of the opportunities created by EMU, while overcoming the considerable regulatory, fiscal and other barriers that still exist. Our advice to clients in euroland is that despite its teething problems, the euro is not going to disappear.
Within the UK, our experience is that activity started from a very low base but is now picking up month by month. In anticipation of customer requirements, Barclays opened 28,000 euro accounts for corporate customers at the end of last year.
By the first week of April, 16,000 were already active. In terms of euro cheques drawn by corporate customers in the UK, the figure for March was more than four times that of January, with a strong month-on-month increase.
Businesses in the UK must realise that as long as sterling remains outside the euro-zone, its use as a trading currency will call for active management.
We believe that, in the medium term, the three trading blocs behind the dollar, the yen and the euro will continue to become more clearly defined and polarised. The volatility of sterling, as long as it remains outside, will depend on whether or not the markets feel the UK is edging towards entry.
The majority of UK companies trading with euroland countries will simply not be able to avoid opening and using a euro account. As the impact of the euro reaches deeper into economic activity, companies selling commodity-type products into the eurozone will be in the frontline, facing the structural changes triggered by a single currency; they will experience growing competition, increased price transparency and, consequently, substantial price erosion. Whether they like it or not, these companies will be forced to examine their cost bases for greater efficiencies and invest more in R&D and to seek greater product differentiation through innovation.
The concept of the ‘creeping euro’, talked about last year, is still very valid today – we are seeing, and will expect to see on a greater scale, larger companies pushing the euro down their supply chain. By next year, the new currency can be expected to have stabilised further and to have gained ground and wider acceptance in the corporate sector.
The euro’s first 100 days may not have been spectacular but perhaps the markets’ expectations were just a little too high. We can now see more clearly that the major changes and structural shifts that businesses and economies are making to align themselves to the euro will take time. They are part of an ongoing process rather than an overnight transformation.
FIGHTING THE STRENGTH OF STERLING
UK exporters tend to price goods and transactions in sterling, both for historic reasons and to avoid foreign exchange risk. Assuming the euro is a success, there will be fewer opportunities for sterling pricing as euroland importers become used to a pan-European currency.
But trading in a foreign currency presents an age-old quandary for exporters – predicting what goods will be worth in, say, six months’ time. If sterling strengthens between the invoice and payment, a UK exporter could end up making a loss.
Fortunately, there are ways of protecting against this exchange risk, by hedging. The most straightforward is to open a foreign currency account and do away with conversion charges. With eleven currencies becoming one, this is likely to become an increasingly popular method of doing business.
Many smaller businesses, however, find foreign currency receipts and payments are out of sync, making a currency account a less-than-perfect option.
A company can also protect its currency income for a set period by means of a forward contract – where the exchange rate is fixed from the outset and the exporter takes on a liability in the form of an agreement to make a future foreign exchange transaction.
Telecommunications consultancy, InterConnect Communications, receives a substantial amount of its income from Europe, all in euros. Managing director Alan Horne says: ‘In the past two to three years, sterling’s strength has wiped off large sums of money for us. We’re now covering ourselves by operating a euro account and forward contracts.’
In January, the company’s financial director Bob Jones booked three forward contracts with Barclays Bank. The contracts, each for 100,000 euros, mature at monthly intervals to cover anticipated euro income. The agreed exchange rate was around 1.42, compared with around 1.51 last week. ‘With the weakening of the euro against sterling we’ve got a pretty good deal on this occasion,’ he says.
Andre Teeuw, is managing director of corporate banking Europe for Barclays
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