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Car Makers Winning From Falling Pound
The fallout of Brexit and the weakening of the pound has led to Britain’s car industry reporting record exports for the 11 months leading up to December. Will the likes of Nissan and Honda benefit and see share values rise?
Car exports for the UK in 2020 total 1.25 million thus far – the highest figure ever recorded – as factories have been forced to increase overtime to meet the demand for British-manufactured vehicles abroad.
Car sector experiences 17-year high but future remains unclear
The fall of the pound – to around €1.2 and $1.25 from €1.35 and $1.5 this time last year – is part of the reason why the automotive industry has experienced such a boost, with reduced regulations and the need for the UK to maintain zero tariffs also cited as factors.
• UK car production in 2020 totalled 1.6m units prior to December.
• This figure is a 9.6% increase on last year and the highest since 1999.
• In November, 170,000 vehicles were produced, a figure previously not seen since 1999.
• Of these 170,000, 33,745 units were produced for the UK market, an increase put down to the rising cost of imports.
• The automotive industry currently turns over £71.6bn annually.
• 169,000 people are employed in car manufacturing, while the automotive industry as a whole accounts for 814,000 jobs.
Nissan and Honda UK operations
This year, Nissan UK announced that it would be expanding production here, giving a jobs boost to Sunderland, where it currently employs 7,000 workers at its manufacturing plant, while in 2020, Honda’s Swindon site will start producing the five-door Civic.
Is the future as bright as it seems?
Brexit and the resultant uncertainty regarding trade deals with Europe and the rest of the world remain a concern for carmakers, with Nissan threatening to go back on its expansion plans if the cost of parts and export charges rise too high.
The chief executive of the UK’s car industry trade body also highlighted the risks a ‘hard Brexit’ posed to the future of the industry, saying that, although “these latest figures highlight the fact that the UK is a globally competitive place to make cars“, success “will continue only if we can maintain the competitive trading conditions that have enabled the UK to become an automotive success story.”
It’s clear that the car industry is enjoying something of a renaissance, but it appears that future investment will depend on the political direction the UK takes in the years to come.
Who are the winners and losers from the pound’s fall?
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Cast your mind back to that surreal period just after Brexit. Remember how discombobulated you felt? Leaderless Britain, Tory party turmoil, the spectacular Boris and Gove fallout, England losing at football to Iceland? The pound was in turmoil too. It fell about 11 per cent.
Actually, that was pretty much expected. Virtually every economist said it was going to be sold off because no one knew what Brexit really meant for the UK economy, so the assumption was it would be bad. The next bit of the summer was not expected — the economy stayed in surprisingly good shape, fears of a post-Brexit recession were put to bed, so the pound rallied.
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Now, sterling is falling again — by nearly 5 per cent this week to its lowest level since the referendum, which is also its lowest in more than 30 years. Why? Because Theresa May, in her speeches at the Conservative party conference, dispelled any idea that the UK was going to backtrack on Brexit and revealed a deadline for setting the divorce process in motion. The currency market took that to mean that the prime minister was angling for a Hard Brexit — a view reinforced by some trenchant rhetoric from the PM. European leaders agreed and markets resumed their negative post-referendum mood.
A so-called “flash crash” at one point dragged the pound down to $1.18 and though that fall has largely been unwound, the pound has ended the week in a weary, battered state. “Error or not, the reaction illustrates that the British exit from the EU has the potential to create considerable disruption on the markets,” says Commerzbank’s Lutz Karpowitz.
Who are the winners and losers?
Foreign tourists are big winners. They flooded the UK in the summer after the big post-Brexit sterling drop, and if they can brave Britain’s weather, they will do so again the next time they have a break.
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So UK tourist attractions, and other parts of the leisure industry such as restaurants and hotels, also benefit.
Other winners are anyone in a hurry to sell a UK asset, such as a house or a company. Foreign buyers may never get a better opportunity. Exporters now have more competitive goods to sell. And hedge funds always like a bear market.
The losers? Brits going abroad. Summer holidays in Europe and elsewhere were painfully expensive and will be more so now, making the idea of staycation holidays more tempting.
Car drivers face higher forecourt prices because the UK is a net oil importer and the price of a barrel of oil is going up. And banks find their sterling assets are now depreciating.
Lots of people think all of us are losers because the UK economy is now in trouble.
Why is the FTSE loving this?
Because many companies in the FTSE 100 and FTSE 250 get their earnings abroad. The likes of HSBC, GlaxoSmithKline and Wolseley are all seeing nice boosts to their share prices. Even the mid-cap 250 index, which has a more diverse group of companies that better reflects the UK economy, is enjoying sterling’s pain, since it is populated by commodities companies. Interest rates are low so the dividend yield from equities is more tempting than yields from other markets.
Caution: this is one way of looking at the FTSE. Another is to measure FTSE companies in dollar terms, and when you do that you see that the FTSE is down over the course of the year. Compared to US companies and other peers, UK companies are underperforming in the long term.
Even so, the FTSE may be benefiting from the surprisingly good economic data since Brexit and the neutralisation, thus far, of fears about recession. There is also the prospect of a weaker pound firing M&A activity.
“While we expect Brexit fears to bite at some stage, the strength of the FTSE 100 is reflective of the fact that Brexit hasn’t had too much of an impact on the UK economy so far,” says Kathleen Brooks at City Index.
Could sterling fall lower still?
Most certainly. Let’s face it: the government doesn’t know how Brexit will turn out, the Bank of England doesn’t know, the market doesn’t know, companies, shareholders, the man in the street don’t know. Many things determine a currency’s rise and fall, but in the pound’s case Brexit is way ahead of other causes.
In crude terms, Brexit could be good or bad for the UK. Right now, Brexit is in the tray marked “Uncertain”. And since the market hates uncertainty, the chances are that traders’ instincts will lean towards selling the pound. Currencies are probably the best proxy for the market’s opinion of a country’s economy, and when the pound fell sharply in the days after Brexit, the market had effectively downgraded the UK. That much was expected by most economists.
What matters to governments and central banks is the size and pace of currency moves. And after a summer lull, when the economy seemed to be doing better than expected, forcing economists to update their sterling forecasts, the pound is again being heavily sold relatively quickly. A pound was worth nearly $1.30 at the start of October. Barely a week later, it is worth closer to $1.24. That’s quite a decline.
Currencies move in strange ways. There is never a smooth path up or down (or sideways). Here’s Richard Bibbey of HSBC: “We’ll likely see a short period of consolidation before a further period lower. However, if we remain at these levels for a period of time, the less likely it is to materialise.”
What does it mean for investors?
Sterling’s fall has already had its impact on equities, and it has also made a difference to the cost of borrowing since the Bank of England has begun resuming the purchase of bonds. The next few weeks will be tricky. Will equities run out of steam? Will yields in gilts rise? There were signs of both towards the end of this week, as the reality of Brexit hit that bit harder.
Much depends on how much further the pound falls. A more sustained sell-off may spook foreign investors in gilts, thereby driving yields higher. Curiously, the way the market works, that may end up halting the pound’s fall. It may also hurt equities, since low bond yields have been a factor in rising share prices by virtue of their inflationary effect on future cash flows of companies. No one said Brexit was going to be easy.
As a consumer, when will I start feeling the impact of this?
Your fuel tank is probably going to cost more to fill and your holidays abroad have already cost more, which means a staycation not too many miles from home is your best bet for next summer.
At some point, the high street will have to weigh up how to factor in the pound’s fall. Retailers’ import prices will rise. They will have hedged against currency risk, but those hedges will expire at some point. They can jack up prices for the consumer or swallow the impact of the import rise for fear of losing the customer.
The chances are that retailers will see their way through to the end of the year and protect their Christmas sales, and take a view at the start of 2020. Much depends on consumer confidence. This is steady for the moment, but never far away from reversing course, particularly if headlines about rising inflation spook shoppers. The headlines had already started on Friday.
What does it mean for the housing market?
House-hunters looking to buy in the UK with foreign currency — particularly the dollar or dollar-pegged currencies — have seen their purchasing power soar in recent months. In London, the effect has been accentuated by falling prices at the top end of the market.
LonRes, a data provider, said average values paid in US dollars per square foot in central London had dropped by 29 per cent between the peak in 2020 and August this year, “making prime central London, for those buying in US dollars, the most affordable it has been since 2020”.
Estate agents reported a surge in interest, if not completed deals, from foreign buyers. David Adams, managing director of John Taylor, a Mayfair-based estate agent, said there had been a 1,000 per cent rise in such inquiries in the month following Brexit compared to the previous month, and interest had been most acute at the ultra high end of the market for homes above £30m. “Many more people have been calling us to say that they think they should be looking for something because of currency,” he said.
However, he was struggling to find the supply of homes to satisfy this demand, since there was a corresponding fall in UK homeowners transacting. “They don’t think now is the right time to move,” he said.
Aaron Strutt, product manager at broker Trinity Finance, said worries among EU nationals living and working in the UK about the prospects of residency controls after Brexit were beginning to lift, and consequently groups such as French and Italian expats were returning to the market.
How could it affect my pension?
Many of the estimated 1.1m pensioners who have retired abroad will see a dramatic fall in the spending power of any UK state or private pension income.
A year ago, £100 would have secured $200 in Australia, one of the most popular retirement destinations for British expats. But this week, the same £100 of income would only return A$169, or 15 per cent less.
There were similar falls in spending power for the estimated 400,000 UK pensioners living in the eurozone who receive the UK state pension. “Currency risk is a major issue for expats,” said Mike Morrison, pension analyst with AJ Bell, the pension provider.
“It is possible to buy a forward contract for currency exchange, which can provide a level of certainty on the exchange rate but they are mainly used for large purchases such as house purchases.”
Mr Morrison says the simplest answer for expat pensioners is to use income from other sources if possible and leave the pension untouched until the pound recovers. “However, this may not be possible if the pension is the only source of income and it looks like the pound is going to remain weak for some time to come.”
What does the rest of the world think about the falling pound?
One school of thought suggested some countries were jealous of the UK. In a world of stubbornly low growth, a weaker currency was one way of making your economy competitive.
Except that if everybody did it, you would soon be embroiled in a self-defeating currency war, which is why a US-led initiative back in January led the world’s developed countries to agree not to target deliberately weaker currencies. Hence when Brexit induced sterling’s plunge, the UK looked as if it had accidentally stumbled on a unique way of getting itself a weaker currency.
This is all very well if you can manage the currency’s fall in a measured way. And that is not what this week’s drop feels like. Opportunists around the world will grab UK assets, which have suddenly become cheaper.
But will foreign investors see the UK in the same favourable light? If they start to pull out their money on a big scale, that poses problems for servicing the UK’s pretty large current account deficit. Bank of America Merrill Lynch says: “The risks are skewed to a weaker sterling next year amid policy uncertainty and constraints on current account deficit financing.” You have been warned.
How can I minimise the impact of sterling’s fall?
Play the currency markets and hedge against sterling’s fall, although it is costly, complicated and by no means foolproof. Alternatively, get on the right side of the pound’s weakness — invest in UK exporters, open a bed and breakfast in a popular tourist town or buy shares in a UK-listed energy company which reports its earnings in dollars.
The other option is to position yourself for the pound’s rise. This is based on believing either that a) sterling has hit the bottom; b) it will rebound on the back of the economy staying resilient; c) Brexit will turn out to be soft and even cuddly; d) a combination of all of these. There were a few economists who believed this a few weeks ago. You may need to wait a while for them to resurface.
Is there anything else that’s going to move the pound either way?
Currencies are two-way. A currency trade happens when one currency is bought and another sold. So when the pound is bought or sold against the dollar, more often than not there are influences on the US side that come into play.
Hence, the US election, the state of the economy and the prospect of rate rises across the Atlantic can all push the dollar higher against the pound. Similarly, eurozone developments will affect the pound’s level against the euro. US and European influences were coming back into play in recent weeks as fears about Brexit’s impact on the UK economy were kept at bay.
That all changed this week. UK politics is back at the wheel driving the pound and the quality of driving is erratic, to say the least.
Additional reporting by Josephine Cumbo and James Pickford
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Brexit: what it means for the British car industry
The prospect of ‘border drag’ is worrying car makers
Brexit could force car firms to source more local parts
The Ford Fiesta is Britain’s biggest-selling car
All of the UK’s automotive manufacturing plants (click on image to enlarge)
The entire automotive industry talks nervously of disruption. Autonomy, China, electric vehicles… these days it’s a case of pick your threat.
In the UK, however, disruption is coming much faster and from a much more traditional source: politics. Brexit and, to a lesser extent, the decline of diesel are probably the two biggest forces acting on our industry right now, and the fate of both, by and large, lies in the hands of the Government and its opposition.
No matter where you stand politically, you’d probably agree that’s not where you’d want to place the future of an £82 billion industry that, in terms of export value to the country, accounts for a whopping 13% overall.
The chief executive of automotive supplier Unipart has warned that Brexit has the potential to wreak even worse devastation on the industry than what occurred in the 1970s. “I fear hard-line Brexiteers are in danger of achieving what that rabble of militant trade unions failed to do: destroying the British car industry,” John Neill wrote in the Daily Mail in May.
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If there was ever a company that tracked the recent downs and ups of our car industry, it’s Unipart, which was once a division of the state-owned dinosaur British Leyland but is now a thriving independent parts and logistics firm.
Neill’s worries are those of the wider industry. Tariffs would be bad, but worse would be the delays resulting from car parts held up at what’s increasingly looking like being a hard border between the UK and the Continent. That threatens to destroy the finely timed movement from supplier to manufacturer that has evolved over years of membership of the EU.
The loss of easy access to our biggest market and parts suppliers could put the brakes on a strong period of growth for British car manufacturing, argues David Bailey, professor of industry at Aston University. From a record 1.92 million vehicles made in 1972, UK car production has slumped, peaked and slumped again, but this decade it came roaring back to 1.7m vehicles (and 2.7m engines) last year, thanks in part to a resurgent Nissan and Jaguar Land Rover, our two biggest manufacturers by far. Brexit could reverse that.
“There’s a real danger we’ll have another decline,” Professor Bailey said. “Production is not guaranteed to be here; it can be shifted around, and we’re in danger of a self-inflicted wound that seriously damages the automotive industry.”
Manufacturing jobs have already been lost – at Vauxhall in Ellesmere Port, at Jaguar Land Rover in Solihull and at Nissan in Sunderland. To what extent they were lost due to Brexit, the slump in diesel sales or simply cyclical market upheavals is a point that has been much debated, but the timing looks ominous.
Brexit so worries Jaguar Land Rover that its normally reticent boss, Ralf Speth, warned last month that a bad Brexit deal would cost the company more than £1.2 billion a year in lost profits and inflict serious job losses. “We want to stay in the UK… but if we don’t have the right deal, we’ll have to close plants and it will be very, very sad,” he told the Financial Times.
Jaguar Land Rover is also reeling from the diesel crisis, as are many other firms. “It’s been a huge issue for the market,” said Bailey. “Government has been all over the place on this.”
In the first six months of this year, diesel demand tumbled by 30% to the point where the fuel type accounts for just a third of sales, down from more than half at its peak from 2020 to 2020. Jaguar Land Rover sales are more than 90% diesel in the UK and the company has seen demand fall by 9% in the first six months of 2020, despite fresh product. The body that represents car makers in the UK, the Society of Motor Manufacturers and Traders (SMMT), has called on the Government to throw its support behind the latest cleaner diesels and help change public opinion that ‘diesel equals dirty’.
Are there any upsides for the car companies?
A hard Brexit would put barriers up and force businesses to look inward, which could boost the UK parts industry. Currently an average car built in the UK uses 44% of UK parts in terms of value. Post-Brexit, car makers might want to increase that to hit ‘rules of origin’ requirements (see below). The lack of tariffs and border hassle could make a UK part that much more competitive compared with an EU part.
For example, Aston Martin and McLaren both use Italian-made Graziano gearboxes. In the event of a hard Brexit, McLaren Automotive CEO Mike Flewitt said he would try to persuade Graziano to build a UK plant. “If the duties were there and it was harming our competitive position, absolutely we would,” he said.
McLaren currently sources 50% of its parts from the EU (outside the UK), a figure that will go down to 40% once it starts making its carbonfibre tubs in Yorkshire in 2020. That decision to shift production from Austria was made prior to Brexit, but we could see more of this. McLaren and Aston Martin have both said they’ve benefited from the fall in the pound’s value since the 2020 vote.
What do UK auto makers want from Brexit?
“We want free trade, zero tariffs, frictionless trade across borders,” Flewitt said. It’s a common refrain. Essentially, they want what we’ve got now: a customs union, free trade, common rules (and a say in how they’re made) and the freedom to hire staff from across Europe. “We need unrestricted access to the single market of Europe, our largest trading partner,” the SMMT said.
Last year, 54% of UK-built cars were shipped to customers in the EU. The SMMT reckons a no-deal shift to World Trade Organization (WTO) tariffs would add £1.8bn to the cost of exports, forcing price increases. Meanwhile, an extra £2.7bn would be paid collectively for new cars coming from the Continent.
Ford puts the blame squarely on Brexit for its loss-making second quarter in Europe this year. “The biggest issue we face is the UK,” Jim Farley, president of global markets, told investors last week. “Brexit and the continued weak sterling has been a fundamental headwind for our European business.”
So what will happen?
The latest white paper from prime minister Theresa May proposes that we stay in a version of a customs union and single market while maintaining the EU’s rules on goods such as cars. So no tariffs, no border checks and no real change, apart from making it more difficult to hire people from outside the UK.
The SMMT called it a “welcome step” that shows the Government is listening, but the hard Brexit wing of the Tory party hates it for proposing we take EU rules without having a say in how they’re made, and have forced amendments to the White Paper. There’s little evidence to suggest the EU would accept either version.
“There’s a sense of relief among auto makers that there’s a desire to stay in the single market, but they don’t know what they’ll end up with,” said Professor Bailey. “That is deterring investment in a very big way.”
What is ROO?
Rules of origin (ROO) are an essential part of a free-trade agreement made with another country to make sure a third country isn’t piggybacking the deal. If you allow a car in tariff-free from country A but 80% of parts in the car come from country C, then you’ve given away a benefit to country C for nothing in return. Trouble is, cars made in the UK are so dependent on EU parts that we would struggle to satisfy ROO when we tried to strike post-Brexit trade deals.
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