The UK current account deficit is set to halve over the next two years amid trade balance improvement and the value of net investment income flows supported by a sharp fall in sterling, the BoE says.
In its inflation report, published yesterday, along with long awaited new monetary policy measures, the UK central bank projected that the current account deficit is set to narrow to around 5 per cent by early 2017 and is expected to halve by 2018.
The report says the fall in sterling will lead to a narrowing in the current account deficit “against a backdrop of modest global demand growth”.
The current account deficit remained very wide at 6.9 per cent of the UK GDP in the first quarter of 2016, although slightly down from a record high 7.2 per cent in the fourth quarter of 2015.
At the time, the numbers reflected deficits on both trade and income flows, in part due to the “relatively strong performance” of the UK compared with its major trading partners in recent years, the BoE says.
The report says: “The new projections in part reflects the less favourable demand conditions in the UK relative to those abroad, which are likely to be associated with a rebalancing of trade and income flows.
“It also reflects support from the sharp fall in sterling, which bolsters exports and discourages imports and also boosts the sterling value of inflows of profits from abroad. The lower level of sterling also improves the UK net international investment position.”
The BoE notes that around 60 per cent of the stock of external liabilities is denominated in foreign currency, compared with more than 90 per cent of the stock of external assets, according to the Journal of International Economics.
In July, BoE governor Mark Carney already said the sterling fall following the Brexit vote should reduce the UK’s current account deficit.
He told MPs: “Movements in sterling such as the depreciation we have seen should on the whole improve the current account balance, and make [the deficit] smaller.”
The bank says sterling depreciation will raise exporters’ profit margins, and could encourage new and existing exporters to increase production.
According to the report, goods export volumes are set to grow next year after an improvement in the three months to May following falls in early 2016 and the second half of 2015.
However, the bank warns that the extent of the improvement in export growth will depend on how UK companies and their trading partners react to June’s Brexit vote.
It says: “UK exporters or international customers could be dissuaded from entering into new trading contracts if either attaches some weight to the possibility of reduced trading access in the future. That would also dampen imports, since exports are relatively import-intensive.”