UK’s super-sized deficit could haunt GBP for years to come
GBP’s plunge since last year’s EU referendum was supposed to be an opportunity to rebalance the UK economy and shrink its colossal current account deficit. But this may not happen, which means it remains a long-term risk for GBP.
This was revealed in last week’s budget where it looks as if it will now not narrow significantly over the next five years. The Office for Budget Responsibility sees the deficit at 4.4% of GDP in 2021 rather than 2.0% it originally envisaged with expectations for 4.6% this year, compared with 5.9% in 2016 and remains the G7’s largest.
This implies that GBP is still over-valued with further falls likely, possibly due to an unpleasant turn in the Brexit talks where signs of striking a trade deal remain uncertain.
The UK used to be able to rely on a positive balance in net investment income ie it generated more overseas investment income than it paid out to foreigners. Following the financial crisis that is in deficit and has never recovered. Meanwhile, whilst exports have grown strongly, so have imports as the UK economy has remained resilient. But manufacturing only makes up about 10% of the economy and with stagnant productivity growth there are limits as to what it can do on the export front.
Currency markets often tolerate large current account deficits for developed countries, particularly if their economy is growing well and have large capital markets to recycle capital, which the UK does have. But once markets focus on current account deficits, the results can be bloody and prolonged as big deficits take a long time to correct.
But it’s not all doom and gloom. Brexit appears to have shaken policy makers’ complacency over the British economy. Tackling productivity is a growing priority, as is exporting and giving the country some form of industrial policy — though measures will take time to play out.
Also, one interesting observation is that the UK mainly runs a trade deficit with the EU, Norway (due to energy imports) and China and it happens to be positive with the rest of the world including with countries such as the US, South Korea and Japan.
Once independent of the EU, the UK might be able to craft an industry and trade policy much better suited to the UK’s particularities — it is the world’s second largest exporter of services for example — and this may help shrink the current account deficit more quickly. But as with all things Brexit related it is hard to know if this will happen.
TECHNICAL ANALYSIS: EUR/GBP more gains to come
Since hitting a peak in late August and unsuccessfully testing support around 0.8760, EUR/GBP looks as if it is working its way back towards highs of over 0.9200.
Indeed, whilst the Eurozone is celebrating robust economic growth, much of the financial press and establishment have written-off the UK’s prospects post Brexit strongly suggesting that holding EURs is far more favoured than GBPs.
Indeed, since the beginning of the month, the EUR has been steadily moving higher and a successful breach of resistance levels above 0.9000 could see it march higher still. Few of the technical indicators seem to contradict that view and even the 200-day moving average has provided support (turquoise blue line).
Resistance can be seen at 0.8971, 0.8995, 0.9013 and 0.9022 with support placed around 0.8920, 0.8903, 0.8881 and 0.8841
By Justin Pugsley, Markets Analyst, MahiFX