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UK Current Account Deficit Narrows "Substantially", but Unlikely to be Sustained

Current account deficit narrows

Image © Winterbilder, Adobe Stock

The UK current account deficit "narrowed substantially" at the end of 2020 reports the Office for National Statistics, falling to £5.6BN in the final three months of 2019.

The deficit now stands at 1.0% of GDP, down from the 2.8% (£8.3BN) in the third quarter of 2019. This is the lowest deficit since the second quarter of 2011 when it read at £2.3BN, or 0.6% of GDP.

The UK's current account deficit is a measure of the country's balance of payments with the rest of the world in trade, primary income and secondary income. The country's entrenched deficit has been an Achilles heal for the British Pound, therefore news that it is shrinking offers a fundamental boost for Sterling valuations.

The shrinkage in the size of the current account deficit is attributed by the ONS to an increase in exports of non-monetary gold and other precious metals, which is described as being erratic.

Also causing the narrowing of the current account deficit, although to a lesser extent, was a narrowing to the deficit on primary income, which was mostly because of a decrease in the UK's payments to foreign investors.

Current account deficit

The current account deficit is essentially the result of the country importing more than it exports. Typically a currency would fall until such a time as imports and exports reached equilibrium. However, Sterling has over the years traded above this equilibrium point, propped up by significant capital inflows from global investors attracted to UK assets.

"A constant capital inflow is therefore needed to underpin the GBP which is challenging in the present dash for cash situation," says Morten Lund, an analyst at Nordea Markets.

When these inflows of international investor capital dry up or reverse, Sterling tends to fall. In fact, the Pound's decline since the onset of the coronacrisis in late February and through March has widely been tipped as being a result of the UK's persistent current account deficit.

"GBP has been aggressively sold in the USD session, supportive of the view that this has been a funding led decline," says Kamal Sharma, a strategist at BofA Global Research. "Brexit is well and truly off the radar for now, but the elephant that is the current account deficit has entered the room."

A lower current account deficit in the future would therefore presumably provide a more solid underpinning for the currency.

We doubt the UK's economic structure and consumption patterns are currently changing to the extent that the deficit will close on a sustainable basis. We would however be interested in seeing how the dynamic has altered owing to the coronavirus lockdown; data which will only be made available in June.

Because the closing of the deficit over the second half of 2020 is down to erratic movements in precious metals, to understand the underlying level of the UK's current account, the ONS have estimated the current account balance excluding trade in precious metals.

On the basis of excluding non-monetary gold and other precious metals, the UK's underlying current account balance narrowed slightly to a deficit of £17.1 billion in Quarter 4 2019, or 3.1% of GDP.

Therefore, if the support of precious metals were to fade, then the deficit would gape open once more, confirming that the Pound will likely remain exposed to the deficit on a fundamental basis.

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