Economic and market briefing: UK growth and trade

The preliminary (output based) estimate of GDP rose by 1.0% in the third quarter of 2012. This followed a decline of 0.4% in the second quarter and over the year to date, real GDP is estimated to have been flat. There’s been a persistent hope that the silver lining to weak UK domestic spending was that the economy could be rescued by an improved relative export performance, but whilst the UK enjoyed buoyant North Sea oil exports in the early 1980s, since 1984 the UK has had a current account deficit in every single year. Even the hefty devaluation of the pound in September 1992 when the pound left the ERM and the subsequent rise in exports didn’t result in a surplus and even the devaluation of 2008-09, which exceeded the markdown of 1992, has so far not delivered a surplus. On average in this 28-year period (i.e., the period of 1984 to 2011 inclusive) the current account deficit has averaged 1.8% of GDP, and over the period  the UK’s cumulative net balance in terms of assets/liabilities relative to the rest of the world has ‘deteriorated’ massively, by between 50% and 75% of GDP.

It might be expected that years of deficits would have led to a growing deficit in international investment income flows, but the data show that even as the UK’s current account deficit expanded in the Blair/Brown years, the surplus on investment income increased. Indeed the surplus rose towards the range of 1% – 2% of GDP as the Global Financial Crisis took hold. What was happening was that the UK earned a materially higher return on its external investments than foreigners earned on their investments in the UK. Thus, during the global financial crisis and its aftermath, natural resource companies such as BP and Rio Tinto experienced windfall benefits from rising commodity prices, arguably reflecting Asian industrialization, and in contrast, foreign investment into the UK was to a large extent in low-earning gilts and bank deposits.

As a new concern, over recent quarters the surplus on international investment income has ceased. In the year to the second quarter 2012 the UK had a deficit on this item of the balance of payments of just over £1bn, and net international investment income no longer counterweighed the UK’s enormous deficit on trade in goods. According to the latest balance of payments numbers from the Office for National Statistics (ONS), the UK’s current account deficit in Q2 2012 was over 5% of GDP, as against the normal figure in recent years of about 2% of GDP.

Whilst commodity prices are an issue, the scale of the challenge is significant: the UK’s gross international investment income peaked in Q4 2007 at £76.7bn, so over 20% of GDP, and in Q2 2012 stood at just £36.7bn. Any resurgence in the global economy would probably support increased profitability of British companies, given the overseas bias in operations, and that would assist a rebuild but it’s noteworthy that the slide into deficit on international investment income has been associated with a widening of the current account deficit to over 5% of GDP, and it is concerning that the UK has a deficit on overall international transactions despite the 24.3% decline in the effective exchange rate index of the pound over 2008.

As to what all this means, correction of a current account deficit must involve at least a slower rate of consumption growth, with adverse implications for UK retailers and UK retail property. The scale of the challenge is clear when we reflect on the reality that whilst over the 12 years to 2004, UK consumption rose in real terms by 44.3% or at a compound annual rate of 3.1%, in the following seven years to 2011, UK consumption actually fell in real terms by 1.8%. This latter period has involved the most marked decline in UK household living standards since the Second World War, and the number suggest that the pain in the retail sector, and for consumption more generally, is far from over.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla