El Niño may just be a weather pattern, but the immediate impact it has on one side of the world can directly and substantially affect currency markets on the other. With forecasters now putting the chance of a very strong weather event developing later this year at more than 90%, global trade and currency movements are the places to watch.

Environmental shifts can very quickly send economic shockwaves around the world, with industries such as food and drink (F&D), as well as others that typically operate on tight margins, left particularly vulnerable. So, for all the headlines we see across the UK and Europe about extreme weather, we must remember the knock-on impact this will have on food inflation, margin pressures and unexpected FX volatility for international trade.

Climate disruption and cost pressures

Geopolitical and climate instability caused by extreme weather can lead to critical, yet unforeseen cost pressures. As F&D businesses navigate supply chain shocks, currency volatility hits profits hard through several distinct areas.

Firstly, European ingredient dependency. Unlike major agricultural economies with vast domestic supply, many European manufacturers rely heavily on imported raw materials, exposing them to both rising baseline commodity prices and adverse FX swings when purchasing inputs abroad.

Secondly, weather-driven disruption, such as reduced water levels in vital transit corridors, such as the Panama Canal, can cause route diversions, shipment delays and soaring freight fees. These shipping and logistics bottlenecks erode profit margins long before an exchange rate even moves on a screen.

Lastly, exposure to raw commodities. Key ingredients most impacted by an El Niño-style event, such as coffee, cocoa, sugar and grains, are traded globally in US dollars. This means supply shocks quickly transform into direct risks for importers, regardless of their local currency.

The unexpected financial implications

So, how do these physical disruption points translate into tangible business costs? In today’s macroeconomic climate, understanding the practical implications is essential.

With ongoing pressures such as the conflict in Iran already exerting upward pressure on inflation, weather-related events double-down on this because global markets are already incredibly sensitive. For example, in an environment where central banks and investors are hyper-focused on inflation, any supply shock feeds directly into market sentiment and interest rate expectations. Had inflation been stable at 2% globally, El Niño wouldn’t be having nearly as substantial an impact.

When extreme weather hits and crop yields suffer, raw commodity prices rise, filtering quickly into broader inflation data. And, as investors adjust their expectations for central bank policy, exchange rates move sharply. Our FX Factor Report, which summarises our research into the F&D sector, shows that unmanaged currency fluctuations regularly wipe out a significant portion of net profitability. For businesses operating on tight net margins below 10%, as many F&D companies do, these swings can eradicate up to one-third of overall profit margins.

The structural reality of FX risk

The mistake is to treat FX volatility as a separate treasury problem. To me, all of this demonstrates that if FX risk hasn’t already become a permanent, structural feature of the operating landscape, F&D businesses need to make sure it is being properly recognised and then address it.

For instance, climate disruption ensures that currency and commodity market volatility remains high. If businesses want to be prepared for the ripple effect beyond immediate market swings, they should consider shifting from reactive responses to proactive, long-term strategic planning, monitoring the strength of USD and its implications for global trade and commodity pricing.

This is because currency instability is disrupting day-to-day business. Our FX Factor Report found that nearly half of decision makers feel FX fluctuations create serious delays between paying global suppliers and receiving customer payments. That gap holds back growth, and research and development, with 45% saying currency instability directly reduces the capital they have available to reinvest.

Historically, smaller F&D businesses have had to work with fewer resources and shorter planning horizons compared with their multinational competition. However, the current environment demands have increased financial sophistication. So, more future-minded SMEs are now adopting formal risk management frameworks that were once exclusive to larger enterprises.

How UK businesses can adapt

In this unstable environment, resilience means planning and preparing for volatility rather than waiting for the storm to pass. UK F&D businesses and manufacturers can adopt several strategies to do this.

Firstly, some businesses choose to formalise their approach with a written hedging policy, which can reduce the influence of short-term market sentiment on decisions. For forward contracts used for payment purposes, techniques such as layering can help avoid over-hedging or locking in worst-case scenarios, which can give a blended rate across a series of payments, rather than exposure to a single rate on a single day.

Another key strategy is proactively strengthening credit profiles. A strong balance sheet provides crucial working capital and helps secure better terms from suppliers and lenders, giving the flexibility needed during climate-driven volatility.

Supply chain diversification and stress testing is vital, too. F&D businesses can mitigate the impact of weather disruptions by identifying both supply chain dependencies and alternative sourcing origins, and including inflationary clauses in new contracts.

Lastly, operational efficiency can be achieved by making data-driven decisions. Tracking costs in real time allows businesses to see whether each product line is still profitable, preventing trading at a loss when input costs and exchange rates shift.

Navigating an unpredictable and volatile future

For the F&D sector, climate disruption and major weather events, such as El Niño, are now direct drivers of financial risk. In an unpredictable global economy, businesses must treat FX risk as a structural reality.

However, while a structured hedging approach may help some businesses manage currency risk more consistently, no hedging strategy can eliminate it entirely. The suitability of any approach will depend on a business’s individual circumstances, objectives and financial position.

By understanding where its supply chains are vulnerable and diversifying sourcing, F&D businesses can build greater resilience to climate-driven market moves, in the face of an uncertain future.

Eliot Bassett is the managing director of Lumon Pay, Corporate Division, a specialist in foreign exchange solutions. With extensive experience in global financial markets, Eliot advises businesses across various sectors on navigating currency volatility and building robust FX risk management strategies.

Lumon has more than 25 years of experience in international payments and currency risk management. It works with businesses that make international payments, providing payment services and forward contracts for payment purposes, alongside regular market commentary. Lumon is a portfolio company of Pollen St Capital, a FTSE 250 company.