What can spoil the party now that most economists expect strong UK growth in 2014? One major concern is the curious behaviour of the UK current account. The deficit reached 5.1 per cent of GDP in 2013, and wide deficits can eventually trigger currency depreciation and slower growth.
The current-account deficit is now about as wide as it was in 1989, which was a cyclical peak in economic activity. Currently domestic demand growth looks set to rise, which should suck in more imports. Entering an upswing with such a large external imbalance is surprising: sterling’s depreciation of around 20 per cent in 2008 should have helped exporters.
Weak export growth can be blamed in part on troubles in the eurozone, the UK’s largest export market, but stagnation in productivity means some of the competitive gain has been eroded by higher labour costs.
Imports have been resilient, despite weak domestic demand over the past four years. Apparently there has been little substitution towards domestically sourced products.
Weak export growth can be blamed in part on troubles in the eurozone, the UK’s largest export market
All this means that, of the 40 or so countries covered by HSBC economists, only the Ukraine, Turkey, South Africa and Colombia have bigger current-account deficits than the UK.
These grim facts need not mean the UK deficit will be a problem. It was no wider in 2013 than in 2012 and so far it hasn’t been damaging. But wide current-account deficits must eventually adjust. Adjustment usually means a combination of currency depreciation and slower growth: the eurozone periphery countries are obvious examples.
Another warning sign can be when the deficit is government-driven and when public-sector finances are looking unhealthy: so-called ‘twin deficits’. And, like many episodes of financial excess, unsustainable current-account deficits tend to occur against a backdrop of low global interest rates and an associated search-for-yield. International creditors often give the country the benefit of the doubt for longer than they should.
Unfortunately, the UK currently ticks many of these boxes. Household consumption has driven overall growth since 2012 and 2013. Investment contracted last year and remains 23 per cent below its pre-crisis peak – although we do expect strong growth this year. And the UK still has a twin-deficit problem.
Indeed, only Ukraine, of the economies HSBC covers, has both a worse budget deficit and current-account deficit than the UK.
We expect UK domestic demand to pick up sharply in 2014. A one percentage-point rise in household consumption growth should cause a 0.5 percentage-point rise in import growth, while a one percentage-point rise in investment growth will push up import growth by 0.2 percentage points. So strong consumption and investment should mean robust import growth.
Stable UK inflation and a recovery in sterling means import prices have started to fall relative to the price of domestic products, making imports more attractive.
The question is whether UK exports can grow faster. The eurozone’s move from contraction to modest expansion should help UK exports, as should higher growth in the US and emerging world. But all in all, we think imports will grow slightly faster in 2014, widening the trade deficit slightly. We now expect the current account deficit to be 3.2 per cent of GDP in 2014.
This research was first published on 21 January 2014.