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If you don't want Poles, you will have a weak pound [CINKCIARZ.PL ANALYSIS]

The past two weeks have been very favorable for the British currency. - Since mid-August, the pound has increased by more than 0.30 PLN. On Thursday, it was above the level of 5.20 PLN. However, the future of the pound does not seem bright, especially if we look at the United Kingdom's current account – comments Marcin Lipka, Cinkciarz.pl analyst.

Marcin Lipka, Analityk Cinkciarz.pl

The situation of the British currency has clearly improved during the past few days. Since the 16th of August, the GBP has gained approximately 6% against the zloty. Changes in the global market are not that strong anymore. However, evaluations of the pound against the currencies that are included in the United Kingdom's commercial trade are approximately 4% higher in comparison to mid-August.

The pound's better condition is mostly a result of relatively positive macroeconomic data. Accelerating indexes of the British industry, as well as consumers sentiments, have worked-off a portion of losses made shortly after the Brexit referendum. Retail sales for July were above the trend. Moreover, jobless claims have decreased instead of increased.

The lack of negative effects of Brexit may suggest that the British economy is resistant, at least in the short-term. Additionally, the fact of no sign of consumption breakdown is clearly reducing the probability of further monetary easing by the Bank of England in the forthcoming months. These signals are of course positive for the pound.

However, if we look at the long-term situation of the United Kingdom, we will continue to see many dangers. The most important is the situation of the UK's current account. This is fundamental in determining the supply, as well as the demand, for the currency. Therefore, this factor is crucial for the pound’s exchange rate in the global market.

Current account

The basic component of the current account (C/A) is most often the difference between export and import (balance of trade in goods). If it's positive, this means that more foreign currencies are entering the country. In the long-term, this should cause an increase in value of the local currency due to a simple rule of supply and demand. In the opposite case, we are dealing with a negative balance (a deficit), which is negative for the particular country's currency.

According to the British Office for National Statistics (ONS), in 2015 the United Kingdom quoted a 126 million GBP (6.9% of the GDP) deficit of trade in goods. In the first quarter of 2015, it was 32.5 billion (7.2% of the GDP). In June, the balance was over negative 12 billion, which was the third worst month in the history of the United Kingdom. This was a fatal result that has shown the country's large external imbalance.

However, the current account not only consists of goods balances, but also of the services balance as well as of primary and secondary income balances. The two latter positions mostly indicate the balance of transfers of national and foreign companies, as well as transfers of the EU funds and the citizens' earnings. The total value of both of these positions is negative 4.3% of the GDP. This means that each year, more than 70 billion GBP (as profits of enterprises, incomes from capital investments or citizens' money orders) is flowing out of the country.

As a result, when adding the goods balance to primary and secondary incomes, we will receive a deficit at the level of 11.5 % of the GDP (7.2% + 4.3%) for the first quarter. This gives approximately 200 billion GBP in the annual scale. Financing such a large negative balance by the inflow of the wallet capital or direct foreign investments, is basically impossible in the long-term. The market would force a serious wear-off of the pound in a certain moment. This would limit import, increase export and would cause a significant reduction of the deficit.

However, there is one element that would clearly decrease this fatal result in the case of the United Kingdom: the services balance. Its positive balance is at the level of 4.7% of the GDP and it reduces C/A to approximately negative 7% of the GDP.

Services as the key to economy's competitiveness

The United Kingdom has developed a special position in the services market. Services equal 45% of the entire export in the United Kingdom. To compare, services equal less than 20% in the case of Poland. According to the ONS data, in 2015 the financial and insurance sector generated more than 53 billion GBP in surplus.

The Brits also specialize in legal, consulting and advertisement services. Last year, these sectors had achieved a total positive result of more than 11 billion GBP. Engineering services, as well as global trade related services, have brought a surplus to the level of 18 billion GBP. Positive balance has also been observed within the categories related to transport (2.3 billion GBP), telecommunications and IT (6.6 billion GBP), and education (6.8 billion GBP).

If we look at the services balance, only the balance of foreign trips is clearly negative (negative 18 billion pounds). Therefore, there is a crucial question: how will the above services work when Brexit actually happens?

Shot in the foot

The positive balance of exchange in services between the United Kingdom and countries from continental Europe are at positive 35 billion pounds. However, it's worth noting that this is not the only value which is endangered by Brexit and the loss of full access to the common market. One of the main reasons for the United Kingdom leaving the EU were immigration matters. If the inflow of qualified staff from other countries is stopped, this may cause problems in keeping the foreign balance of services at the level of approximately positive 85 billion GBP.

However, it's no secret that a significant portion of the United Kingdom's advantage in the services sector is related to winning experts from the entire world. It's possible that this process may significantly wear-off, not only due to a limit regarding the EU market.

Brexit has also shown a social aversion towards immigration. This would probably result in legal changes. The United Kingdom may also stop being trendy among professionals. Moreover, the British academies may lose prestige among foreigners. All of this may cause the competitiveness of the British services sector to decrease. This should result in reduction of its positive balance abroad.

In conclusion, the British “no” to the European Union, may bring many negative consequences. One of them being the risk of deterioration in balance of foreign services, which is the pillar of the United Kingdom's economy, as well as its competitiveness advantage abroad.

This may result in a further deterioration of the current account balance, as well as an increase in fundamental downward pressure on the pound. This may cause the Brits' financial situation to deteriorate, in comparison to situation of citizens of other leading developed countries.


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