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Holding a referendum when we have a historically high deficit is not good planning

  • Monday, May 22, 2017

Mark Carney Governor of the Bank of EnglandConcerns about the closeness of the UK referendum on EU membership are starting to dampen business and consumer confidence. Recent surveys have shown that UK households are optimistic about their personal finances but expectations for the wider economy, due to the uncertainty of the EU referendum, have fallen.

Government figures have confirmed that the UK economy expanded by 0.6% in Q1 2016 matching the growth we achieved in Q4 2015. The economy’s strength was supported by higher consumer spending and business investment.

However, the Office of National Statistics (ONS) confirmed that the UK current account deficit has recently surged to a record high and The Bank of England (BoE) warning that the rising current account shortfall is leaving our economy vulnerable in the event of a UK Brexit.

The deficit is the gap between money coming in and out of the country. This gap rose to 7% of GDP in Q4 2015. This deficit has been progressively rising over the past four years and last year stood at 5.2%. This recent rise is the highest since the end of World War 2. No other country in the OECD has such a high current account deficit as Britain. Economists feel that the current account deficit is now so large that it leaves the UK vulnerable.

One of the main reasons that this deficit has grown is down to the large number of FTSE 100 companies involved in energy and mining that have repatriated much reduced oversees profits. It is likely that this commodity driven downturn will recover. However,  recovery will be dependent upon OPEC oil production rates, US interest rates and China consumption.

The UK current account deficit is evidence of us as a nation living beyond our means and in need of foreign capital to support consumption. BoE Governor Mark Carney has indicated that the UK economy remains heavily reliant on foreign investment which helps plug our current account deficit.  Global investors have so far chosen to overlook the deterioration in the current account due to the attractiveness of London and the UK as a whole. This may change as June 23rd draws nearer and polls tightening. Foreign investment is assuming that the British people will do the rational thing and stay within the EU.

Economists now believe that if the UK were to pull out of the EU, the economy may face a sudden decline as inward investment into the UK could significantly fall. In turn the value of £ Sterling would fall reflecting the resultant low demand.

The possibility that Britain may opt out of Europe will inevitable rattle markets. £ Sterling has lost ground by 9% since late 2015 and UK gilt spreads have been increasing. This is always an early sign of concerns and the pricing in of risk.

There is no sovereign debt crisis looming as we borrow in £ Sterling. We could let our exchange rate take the strain by devaluing our way out of any immediate trouble. Unfortunately a Britex will compound this problem significantly and holding a referendum when we have a historically high current account deficit is not good planning.

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Chris Davies

Chris Davies

Chartered Financial Adviser

Chris is a Chartered Independent Financial Adviser and leads the investment team.

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