Business outlook: Exporters look to break free from the currency squeeze

British manufacturers will be hoping that the next 12 months can only get better, after a turbulent year dominated by the impact of the strong pound. The 13 per cent surge in the value of sterling against the German mark last year severely hit exporters to continental Europe and but all the signs are that the painful squeeze on profit margins will continue.

Even firms with no major overseas markets felt the pressure in 1997 as cheaper imports flooded in, while large engineers with far-flung global interests suffered when translating their profits into sterling.

The result was that share prices fell behind. The FTSE General Industrials index lagged the broader market by 18 per cent while the unloved Diversified Industrials sector, helped by two profit warnings from BTR, underperformed by over 30 per cent.

Although the pound may weaken slightly during 1998, most forecasters predict it is unlikely to give up all the gains it made in 1997. Most economists are expecting further interest rate rises to curb inflation, with base rates unlikely to drop back until the second half of 1998. Higher rates will inevitably continue to support sterling.

Those hardest hit by the strong pound will remain groups such as British Steel, which price products in German marks on world markets. British Steel has accelerated the contraction of its workforce to cut costs, but the longer the strong pound continues, the harder and more costly it becomes for companies to hedge against currency risks. Similarly, businesses which have long-term supply contracts in continental Europe, such as Laird, the car parts supplier, look vulnerable.

Another question mark hangs over demand from the home market, with some forecasters predicting that the consumer boom will begin to fade as the stream of building society windfall payouts dries up. Though any impact on manufacturers would be gradual, the first signs could come in the car market, which is unlikely to grow much further than the 2.1 million sales due for 1997.

Elsewhere, manufacturers will become increasingly preoccupied with consolidation. European defence contractors and their suppliers will contemplate moves to create a single, European giant to challenge the US.

British Aerospace and GEC are ready to get together with their counterparts in Germany and Italy to form large defence groupings that can compete on a global scale. But a question mark remains about the attitude of the French government. If it continues to resist deals involving Thomson, the defence electronics group, British defence contractors may decide to look elsewhere - possibly even the US - for tie-ups.

The steady streams of bids will continue, as globalisation becomes the by-word in the metal-bashing sector. As the recent offers for T&N, Morris Ashby and Menvier-Swain show, foreign predators have been keen to buy UK manufacturers as a way to build up their positions in Europe. Meanwhile, large British engineers like Siebe and TI are likely to pursue strategic acquisitions in the Far East and Latin America.

- Peter Thal Larsen and Chris Godsmark