Fluctuating pound sterling – what does it mean for small businesses?

This article was updated on 4 October to reflect the government's U-turn on plans to scrap the 45p income tax rate.

Following the biggest tax cuts in 50 years, the value of pound sterling slumped against other currencies.

But why did this happen and how could small businesses be affected?

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Why is pound sterling fluctuating?

As part of the mini-Budget delivered on 23 September, the chancellor, Kwasi Kwarteng, announced an estimated £45 billion of tax cuts.

These included:

• reversing the National Insurance rise
• freezing corporation tax
• abolishing the 45 per cent income tax rate
• a permanent stamp duty cut

In the days following his address, the value of the pound fell to a record low against the US dollar.

This was caused by unsettled investors selling the pound in response to the new government’s tax plans.

The Treasury wants to pay off its tax cuts by borrowing more money, which will leave the UK with a higher spending deficit and a lot of extra debt.

A knock-on effect of a fluctuating pound is that the cost of government borrowing has increased to more than four per cent (up from one per cent in January 2022).

What’s more, with the prospect of higher inflation and interest rates, several mortgage lenders have withdrawn products for property buyers.

More tax cuts on the way?

Despite investors reacting negatively to the mini-Budget, Kwarteng initally said that he wants to make further tax cuts.

In an effort to reassure financial markets, he said: “I’m confident that with our growth plan and the upcoming medium-term fiscal plan – with close co-operation with the Bank [of England] – our approach will work.”

Ahead of the Conservative Party conference, the chancellor announced that the planned scrapping of the 45 per cent income tax rate wouldn't go ahead.

This caused the value of the pound to rise marginally. Keeping the 45 per cent tax rate will save £2 billion, meaning the overall cost of the tax cuts falls to £43 billion.

Bank of England steps in to stabilise economy

The government’s financial plans have been criticised by the International Monetary Fund, which said they’re likely to ‘increase inequality’.

Meanwhile, Labour leader Sir Kier Starmer said the tax cuts need reviewing ‘urgently’.

In an attempt to reassure investors and stabilise the economy, the Bank of England announced that it would buy as much government debt as necessary on a temporary basis.

How will small businesses be affected?

A weaker pound affects the cost of pretty much everything, from fuel to food. For example, the UK imports up to 50 per cent of its food.

For businesses struggling with higher energy bills, this means extra pressure on running costs as well as the potential need to increase prices.

Earlier this year, our SME Insights Report revealed that 70 per cent of business owners considered rising costs to be their biggest threat to survival. That figure is likely to be a lot higher now as 2023 approaches.

For small businesses, weak sterling and rising costs could have a negative impact on:

• cash flow
• growth plans
• business maintenance and upkeep
• customer numbers and sales

Consumer costs could keep rising

If the value of pound sterling falls again it could lead to higher inflation, which would have a knock-on effect for businesses and consumers.

Current economic conditions mean that over the coming months consumers could have to deal with higher costs for:

• essentials like food and fuel
• energy bills for gas and electricity
• mortgage repayments or rent

According to research firm Pantheon Economics, a falling pound could increase the cost of living by 0.5 per cent in 2023.

An even higher cost of living will mean consumers spend less (particularly on non-essential products and services), which could have a negative impact on the profitability of small businesses.

Higher costs for importing businesses

A weaker pound sterling causes uncertainty for businesses that import and export goods.

Importing businesses are likely to be hardest hit. This is because the lower value of sterling makes it more expensive to import goods from other countries.

Businesses can try to combat this by absorbing the cost and trying to drive more sales or increasing their prices. Either strategy could lead to cash flow problems if the pound continues to perform poorly.

Exporting businesses could benefit

On the other hand, there are some benefits for businesses that export goods to other countries.

Products exported from the UK will be more affordable abroad, which could lead to higher demand and sales.

What could happen next?

The Bank of England has confirmed it won’t increase interest rates before the next meeting of the Monetary Policy Committee on 3 November.

However it’s said it ‘won’t hesitate’ to increase the base interest rate from 2.25 per cent, with some commentators suggesting it could reach almost six per cent next year.

The government is due to give more details of how it’s going to fund the tax cuts in the coming weeks.

This update, being described as a ‘medium-term fiscal plan’, will also include full growth and borrowing forecasts from the Office for Budget Responsibility.

How will the pound’s fluctuating performance impact your business? Let us know in the comments below.