The weakness of the dollar and the pound could leave UK fmcg manufacturers facing higher costs for materials. Mintec's Andrew Larkham reports

Few food and drink bosses dream of immersing themselves in the vagaries of foreign exchange trading, but with dramatic shifts in currency markets likely in the year ahead, those that have not will need to get up to speed especially when it comes to the US dollar.

While the global recession has kept a lid on inflation this year, that will not last forever. The dollar has already weakened against more or less every traded currency in 2009, as traders pre-empt forthcoming inflation and absorb the effects of low interest rates.

Commodities typically increase in price as the dollar devalues, as vendors seek to protect their purchasing power. For example, a Brazilian coffee plantation owner selling to the world market in dollars must pay his workers in local currency. When the dollar falls in value, he must either raise asking prices or absorb the increased costs. Knowing demand is strong for coffee, he'd prefer the former.

As one of the world's top trading nations, the UK relies heavily on imports and exports for its economy to function, making it susceptible to these shifts especially when the euro increases in value.

One effect of a weaker dollar has been the appreciation of the euro. This has caused difficulties for UK companies needing to import materials from the Continent especially if they have not seen increased sales from greater exports.

The long-term prospects for the dollar do not look good. The Chinese authorities, who hold about two trillion dollars in reserves, are making noises that they will divest heavily. They have not done so yet, as if they did their remaining holdings would devalue as they flood the world market.

It would also take a significant increase in US central bank interest rates and a cut in the number of US bonds being sold for the dollar to regain strength. Neither option is palatable to the US government. The UK food industry must therefore hedge against the very real chance that the dollar will lose yet more purchasing power over the next couple of years.

Fmcg manufacturers, especially those producing commoditised products, will likely be hit hardest. If a company imports Italian durum wheat to make pasta, for example, it is unlikely to recoup the lost margin from higher sales. Conversely, a company that makes ready meals may benefit, as there is more opportunity to create niche products with more added value.

If the dollar weakens gently, companies may have time to adjust. However, Saudi and Russian authorities indicate they may switch from selling crude oil in dollars to euros, which could trigger others to follow suit. With the pound so weak against the euro, this would mean a significant rise in the cost of imported materials.

UK companies will have to counter by marketing harder overseas, especially in the Eurozone, increasing foreign sales to compensate or hope the pound strengthens. It's set to be a tense year.