Alarm bells sound over record deficit: Growing gap in the current account could mean markets turn against UK, experts warn

The growing current account deficit could leave sterling exposed
The UK economy has given investors little cause for concern recently. But one of our vital statistics is worrying, and experts are warning of trouble ahead.
Our current account deficit – which shows how much more we pay out overseas than bring in – is the worst since records began in 1948. In simple terms, cash is flowing out of the UK at a much faster rate than it comes in, and this has only worsened in the last year. Inward investment in the UK has not been strong enough to act as a counterbalance.

GIANT DEFICIT

Latest figures from the Office for National Statistics show the deficit stood at £97.9bn for the whole of 2014, up from a considerably lower £76.7bn in 2013. This equates to 5.5 per cent of GDP at current market prices, and is the widest the deficit has been for 60 years.
The Bank of England’s financial policy committee has already warned the current account deficit is high compared to other nations, and is watching the figures closely.

VULNERABLE

Meanwhile, the fiscal deficit – or government spending in excess of revenue – is 5.3 per cent. Now some experts are concerned that, set against the uncertainty of the upcoming Europe referendum, markets could turn against the UK economy.
“One particular vulnerability is the very sizeable fiscal and current account deficits the UK has been running in recent years. These may weigh much more heavily on investor sentiment when set against a febrile political backdrop,” says Bill McQuaker from Henderson Global Investors.

FRAGILE FIVE

He worries the UK could face a “Fragile Five” moment similar to what happened back in 2013, when international investors suddenly turned against five of the most popular emerging markets – Brazil, India, Indonesia, Turkey and South Africa.
Their economies were deemed vulnerable as many believed their deficits were too high. If the US raised interest rates, these countries would struggle, or so the thinking went. Seemingly overnight, market participants started selling out of their holdings in these countries. Their equity markets, currencies and government bonds were smashed up overnight.
They were all grouped together under the Fragile Five banner and after the rout it took over a year for their economies to recover.

COMPARISONS

Interestingly, the average deficit of a Fragile Five economy was 4.6 per cent in the current account, and 3.5 per cent in their government budgets. This was deemed too high – but the UK’s deficits are much larger at 5.5 per cent and 5.3 per cent respectively.
McQuaker says this could be a source of trouble further down the line. “The pain may not be felt instantly, but recall how markets turned on the so-called Fragile Five emerging markets during 2013... Perhaps we’re fragile too?”

INVESTMENT SLOWS

The UK economy is very different to the emerging markets. One of the richest countries in the world, we have long been perceived as a safe and stable place to invest.
But that does not mean the UK is immune to negative sentiment from international investors. Interestingly, over the last year foreign direct investment (FDI) in the UK has begun to weaken.
This reflects the risk of Britain leaving the EU, and it “is already having an impact,” says Nathan Sweeney from Architas.
“FDI flows into the UK have been negative for 12 months and really this is being driven by the uncertainty around the political situation in the UK.”

STERLING

If investors do believe the UK looks fragile and outflows accelerate, sterling is likely to suffer. An extreme fall in our currency happened on Black Wednesday in 1992, when hedge funds bet on a massive slump in sterling, and the Treasury spent £27bn propping up the currency.
“If we are [fragile] the cost will be a weak currency and, in the worst case, higher interest rates. Many years have passed since the Bank last raised rates to protect sterling after Black Wednesday. It is not unthinkable they would do so again,” says McQuaker.

FIXING THE DEFICIT

Anna Stupnytska from Fidelity Worldwide Investment says the current account deficit is “concerning” at recent levels. “We are in quite a vulnerable position given the uncertainty around the Europe referendum,” she says.
But Stupnytska is more positive for the longer term, and believes the overall balance of payments deficit should rectify itself when growth accelerates in the rest of the world.
This is because the imbalance has not come from the balance of trade, which has been shrinking.
Instead, the problem is with the account balance, which is the difference between what UK investors are getting from their investments abroad, and what overseas investors gain from the UK. This is partly because the UK has been growing faster than other nations, she says.
“This is what has been driving the deficit in the current account,” Stupnytska says. “It seems to me as the rest of the world picks up and interest rates rise, this [deficit] should naturally reverse and close back.”

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