Battered by currency swings, European firms unpick global production model

Mon Apr 6, 2015 3:15am EDT
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By Martinne Geller

LONDON (Reuters) - A dramatic fall in the euro has created an opportunity for European manufacturers to enjoy cheap production costs at the bases from which they can supply world markets.

But after months of sharp shifts in foreign currencies, many of these companies are simultaneously reworking strategy in the hope that by the time of the next sudden tilt they will be operating in more diverse local markets around the world.

Sweden's Volvo Cars is one such firm embracing regionalization. Last month it announced plans to build a $500 million plant in the United States, looking past the dollar's current strength to build in a longer-term protection.

"We're eliminating short-term currency fluctuations, which are never good for long-term commitment to customers in different regions, and we're creating a natural hedge," explained Volvo Chief Executive Hakan Samuelsson.

"Natural hedges" occur when a business's structure protects it from exchange rate volatility, such as when suppliers, factories and customers operate in the same currency.

That kind of model is typical for makers of perishable food and drinks that need production bases close to their delivery addresses, but it's less common for manufacturers of more durable goods like automobiles, electronics or clothing that often prioritize cheap labor and economies of scale - at least until recently.

In recent months their model has been challenged by big moves in the euro and the dollar as the European Union and the United States' economic outlooks diverged sharply. Last October the U.S. Federal Reserve announced it would halt the massive bond-buying program launched five years ago to prop up its battered financial system, because an economic recovery was on track. But in January the European Central Bank kicked off its own program of so-called quantitative easing in an attempt to revitalize the zone's moribund economy.

As a result the dollar and euro currencies sharply diverged too, and in the last nine months the cost of hedging against future volatility between them has roughly tripled. While that means far more players in the $5 trillion a day market have been actively guarding against swings in currencies, it also shows it is three times more expensive to do so.   Continued...

A picture illustration shows U.S. Dollar and Euro banknotes on a pair of scales in Vienna March 11, 2015.  REUTERS/Heinz-Peter Bader