Look, we’re not going to lie. The UK has had a rough decade, and the outlook is even worse. It has the highest inflation rate of any G10 country, the weakest growth forecasts, and an external deficit that would make Argentina blush.
That has led to an outpouring of angst over the UK. Just yesterday, Deutsche Bank warned that the country faced a balance of payments crisis that could send sterling hurtling down 30 per cent against other major currencies. Just to moderate the current account deficit back to its 10-year average would require a 15 per cent drop. Here’s DB’s Shreyas Gopas.
A balance of payments funding crisis may sound extreme, but it is not unprecedented: a combination of aggressive fiscal spending, severe energy shock, and a slide in sterling ultimately resulted in the UK having recourse to an IMF loan in the mid 1970s. Today, the UK does retain some key lines of defence against a sudden stop, but we worry that the risks are rising nevertheless.
FTAV went through the DB note yesterday, and although we’re also (very) worried about the UK, we’re wondering whether people aren’t getting a little overwrought?
First of all, as our colleague Adam Samson pointed out earlier today, while sterling has been jittery lately, in trade-weighted terms its still well above the lows seen after Brexit and the coronavirus nadir in 2020.
Sterling is definitely having a terrible time. But it’s worth noting that it is still significantly above its historic lows of 2016 and 2020 on a trade-weighted basis. (EUR is a rly big weight and while it’s up against GBP this year, it’s not up nearly as much as USD). pic.twitter.com/vjaGUp8qfv
— Adam Samson (@adamsamson) September 6, 2022
Of course, sterling can and probably will have to fall further. But the UK does have some important advantages that makes chatter over an IMF bailout seem a bit preposterous.
There are two classic ingredients in a vintage emerging-markets crisis: managed exchange rates and borrowing in an overseas currency. When the local currency depreciates, that overseas debt burden mounts, weakening the currency further and triggering a spiral that can end in sovereign bankruptcy, an IMF bailout and dreaded “structural reforms”.
But the UK has an entirely floating exchange rate and zero foreign debt, which allows it to absorb the necessary external adjustment without things spiralling into insolvency.
The overall result is likely to be economic pain, faster inflation as the cost of imports climb, fewer overseas holidays for Brits and more English football clubs “owned by dubious oil states”, as former IMF economist Chris Marsh said in an excellent Twitter thread on the situation. Not great, but not a cataclysm.
Is the UK experiencing a balance of payments crisis?
There is some chatter about this given the deteriorating fiscal position and sterling weakness.
Indeed, the @FT’s @alphaville point us to Deutsche Bank note that a “sudden stop” is not a mere tail risk.
A thread…
— General Theorist (@GeneralTheorist) September 5, 2022
Barring a truly atrociously bad policy response — like stripping the Bank of England of its independence — the idea that investors will refuse to fund the UK is simply fanciful.
UK government debt remain a popular haven among central bank reserve managers. Indeed, their gilt holdings have climbed in recent years to $580bn worth at the end of the first quarter. The UK also has a large domestic buyer base that can be cajoled into buying gilts, and international buyers that simply need greater compensation for the risks of the currency falling further.
At the moment, 10 year gilt yields are still below 3 per cent, and credit default swap prices indicate a de minimis fear of any UK creditworthiness problems. They’ve nudged up, but the UK is not Greece-on-Thames quite yet.
So we need to get a grip. Things are bad. Really bad. But not IMF bad.
Source: Economy - ft.com
