The UK’s current account deficit widened substantially in the final quarter of 2020 as the demand for goods imports increased and earnings on investments abroad were hit by the covid-19 crisis, confirming a fundamental Achilles heal of Pound Sterling valuation remains resolutely intact.
In the fourth quarter of 2020, the UK’s current account balance excluding non-monetary gold and other precious metals widened substantially, says the ONS, from a deficit of £13.8BN in Quarter 3 (July to Sept) 2020 to a deficit of £22.8BN in Quarter 4 2020 or 4.2% of GDP.
On an annual basis, the current account deficit widened to £73.9BN in 2020 from £68.6BN in 2019. The UK’s current account balance is a measure of the country’s balance of payments with the rest of the world in trade, primary income, and secondary income.
The ONS says the wider trade deficit was driven by a recovery in the import of goods into the UK as global trade started to recover from the lows of early 2020, and there was continuing evidence of stockpiling in preparation for EU exit after the end of the transition period on 31 December 2020.
The UK maintains a surplus in the trade of services, but government restrictions diminished this surplus to combat the coronavirus pandemic, specifically in transport and travel services.
A current account deficit places the UK as a net borrower with the rest of the world, indicating that the UK’s overall expenditure exceeds national income.
It means that the Pound’s value is to a degree reliant on the flow of capital into the UK from foreign sources, putting it at risk of shifts in global investor sentiment.
“The implication is GBP/USD will continue to trade at a discount to its fundamental equilibrium (around 1.5500) to attract long-term investment flows and finance the UK’s current account deficit,” says Elias Haddad, Senior Currency Strategist at Commonwealth Bank of Australia.
This contrasts to a country – for example, Australia – which exports and earns more than it imports and spends abroad, thereby providing a solid foundation for the Australian Dollar.
“The UK must attract net financial inflows to finance current (and capital) account deficit, which can be achieved through either disposing of overseas assets to overseas investors or accruing liabilities with the rest of the world,” explains the ONS.
The UK’s income accounts were meanwhile impacted in two ways in the final quarter:
- Earnings on investments abroad were more impacted by economic uncertainty because of the coronavirus (COVID-19) pandemic.
- Payments to EU institutions increased as the UK reached the Multiannual Financial Framework’s final year (MFF) and supported the EU’s coronavirus response increasing the secondary income deficit to £28.2 billion in 2020.
UK earnings on foreign direct investment abroad continued to recover in the fourth quarter of 2020 following a significant decline in the second quarter of the year, which coincides with the covid crisis market panic.
The ONS reported that money found its way into the UK as overseas investors returned to equities in the fourth quarter, as markets rallied and deposits from overseas banks increased.