It’s not just your financial investments that Brexit might hit. A British departure from Europe could be bad for your wardrobe too.
The European Union membership debate has already hit the pound, sending it to its worst week against the dollar since 2009. Analysts have warned it could get worse, with Goldman Sachs Group Inc. saying a vote for Brexit at the June 23 referendum could slice another 20 percent off sterling versus the greenback, putting at levels last seen in 1985.
The problem for British retailers is that they mostly pay for products from factories in China and south Asia in dollars. Most retailers will have hedged their currency exposure for the next six to nine months. But senior executives estimate that if the pound continues at its current weak levels — or even falls further on a vote for Brexit — then the impact will be painful when those hedges expire.
One senior retailer reckons that if the pound continues at this level for the next six months or so, then clothing price rises in the low single digit percentage point range will be inevitable.
That doesn’t sound like much. But statistics show, in the UK, consumers enjoyed more than a decade of deflation as manufacturing moved to emerging economies, and “value” retailers such as Primark and the supermarkets began selling their cheap chic. Prices spiked six years ago, thanks to spiralling
cotton costs. But there’s been little or no clothing
The industry actually has a decent amount of ammunition. For one thing, retailers can negotiate for better deals with suppliers, who have lower input costs because of the drop in oil and other commodity prices, such as cotton. Retailers can also move their manufacturing orders around, for example, from China to Bangladesh, to benefit from lower labor costs and in some cases lower tariffs.
Europe could also be part of the solution, though that’s a big could. With the European Central Bank potentially preparing for more easing, the pound hasn’t weakened quite so much against the euro — in fact, it’s still stronger than its five-year average, despite recent declines.
It’s an open question whether this strength would survive a Brexit vote, not to mention whether the trade agreements with individual countries in the region can be recast quickly enough and favorably enough for British retailers to move to Europe to offset the problems with the dollar.
Retailers could also repatriate production. Unfortunately, the amount of clothes made in Britain is tiny. So renegotiation, relocation and repatriation just won’t be enough: the hit from the pound’s slump against the dollar has been so extreme, and Asia accounts for such a big part of British retailers’ sourcing. Analysts at UBS estimate that on average, British clothing and home furnishing retailers source about three-quarters of their goods from suppliers in China and south Asia.
The gross margin — the difference between how much it costs retailers to manufacture and transport the goods to their stores and the price they sell them for — is typically between about 50 percent and 75 percent. So, there’s room for shrinkage there. Unfortunately for value players like Primark, their tighter margins mean less wiggle room when costs rise.
Associated British Foods, Primark’s parent, has said that it won’t put prices up because of adverse currency movements. Others may be less willing to take the hit on their profits. That means only one thing: fatter price tags. So buckle up for Brexit — even if that belt gets a little more expensive.