CHART OF THE WEEK
With a relatively high turnout and 51.9% of votes cast in favour of Brexit, the UK has opted out of the European Union. The next step therefore is negotiating a new relationship with its main trading partner, the EU. The markets reacted fast and the pound sterling fell sharply. Since Thursday evening, sterling has fallen 9% overall against other currencies. The UK’s current account deficit is substantial, amounting to 5% of GDP. Will this deficit shrink on the back of sterling’s fall? Things might not be so straightforward.
OUR ANALYSIS
The UK’s current account deficit is made up of a very significant goods account deficit, which has been hovering around 6-7% for almost a decade, a growing services account surplus in the region of 4%, and an investment income account deficit amounting to about 5% of current GDP.
- Sterling’s fall should improve the UK’s investment income account since a large part of the country’s liabilities are denominated in sterling whereas many of its assets are held in foreign currencies. However, leaving current risk aversion aside, UK interest rates will most likely rise, in particular due to a higher probability of inflation. In downgrading the UK by two notches to AA, the S&P ratings agency refers to a marked deterioration in the nation’s external financing conditions.
- In terms of the services account, the surplus maintained from financial services traded with the EU represents approximately 1% of GDP, and leaving the EU could significantly weaken the UK’s ability to access this market.
- As for the goods account, with exports accounting for 15% of GDP and the manufacturing sector representing 10%, any positive impact from exports will be slight relative to the overall deficit.
The upshot is that the UK’s current account deficit, which is already one of the largest amongst developed countries, could remain very high and continue to drag on the pound sterling in addition to becoming a risk to the nation’s economic wellbeing.
The opinion expressed above is dated June 24th, 2016 and is liable to change.
This document is not pre-contractual or contractual in nature. It is provided for information purposes. The analyses and descriptions contained in this document shall not be interpreted as being advice or recommendations on the part of Lazard Frères Gestion SAS. This document does not constitute an offer or invitation to purchase or sell, nor an encouragement to invest. This document is the intellectual property of Lazard Frères Gestion SAS.
