Pound heads back to dark days of 1990

Pound heads back to dark days of 1990

By Edmund Conway, Economics Editor
Last Updated: 1:18AM BST 30 Mar 2007


Economists have raised the alarm over the future health of the pound, after new figures showed the current account has yawned to the biggest deficit since 1990.

They warned that sterling faced a significant fall in the coming years as investors realised that the UK is living well beyond its means.

The deficit on the balance of payments rose to a record high of £12.7bn in the final quarter of 2006, the Office for National Statistics said. As a percentage of Britain's gross domestic product, this is 3.8pc, the highest level seen since 1990.

Experts said that the increase in the shortfall was the latest sign of the North Sea's demise as an energy producer and warned that as Britain's oil and gas exports fell in the coming years, the current account would widen to worrying levels.

The increase in the gap was far bigger than economists expected, and they warned that this could have severe consequences for the long-term health of the UK economy. A country with a large current account deficit will often see its currency depreciate in the following years, they said.

However, analysts also warned that the numbers indicated that Britain was starting to lose its talent at earning an unusually high return on its assets abroad.

In previous years, Britain's current account has been supported by the fact that UK firms have tended to earn more on their overseas investments than foreign companies have in the UK.

Michael Saunders, chief UK economist at Citigroup, said this appeared to be changing. He said this rate of return was dropping, and warned that there would soon be "some pretty appalling current account figures", saying the deficit could pass 5pc within two years. This is still far short of the US, where some expect the deficit to surpass 7pc in the coming years, but is still extremely high by the standards of developed countries.

Furthermore, said Mr Saunders, the current flow of money into the UK from the Middle East, which is helping to support the pound, would not last forever.

"So far, the worsening current account deficit has not been a big negative for sterling," he said. "But, at the very least, the worsening current account suggests that the Monetary Policy Committee is unlikely to be able to rely on sterling strength as an alternative source of restraint, rather than higher interest rates.

"And, if sterling weakens (in the absence of UK economic weakness) then the UK's medium term upside inflation risks - and need for interest rates to rise - would be correspondingly greater."

A Treasury spokesman said: "Underlying growth in exports is expected to remain robust this year as growth in UK export markets strengthens on the back of stronger demand from the euro area."

The figures also revealed a sudden dive in the UK's savings ratio, indicating that many Britons are being forced to dig into their savings to finance their current spending. The ratio, which charts the amount of national income being set aside, was 3.7pc in the fourth quarter of 2006. This is the lowest level since 2004, and is far lower than the long-run average.

The drop in savings could prefigure a fall in consumer spending in the coming months as shoppers cut back on their purchases, experts predicted.

And in a further sign that households are tightening their belts, the pace of house price inflation started to slow last month, according to figures from Nationwide. It said this measure of annual property price increases dropped from 10pc to 9.3pc.

After a year of unexpectedly strong growth, many now think the property market is cooling noticeably, although in pockets of the country including London and the South-East, a shortage of supply and massive demand for prime housing have pushed prices higher.

http://www.telegraph.co.uk/finance/2806502/Pound-heads-back-to-dark-days-of-1990.html