Is it the British pound’s turn in the doghouse?

Too much Europe

In terms of the U.K.'s trade performance one of the problems seems to be its heavy dependence on Europe. Accounting for the Rotterdam effect — where U.K. goods are shipped to world markets via North European ports — Europe absorbs just over 40% of U.K. trade. The impact of austerity measures in peripheral Eurozone countries have naturally led to declines in import volumes with Spain for instance shifting from persistent large current account deficits to steady surpluses. This is mirrored by the U.K.'s current account deficit with EU countries doubling to 4.5% in just five years. So in a sense, GBP, and the U.K. in particular, is a victim of these savage austerity programmes across much of the Eurozone.

Meanwhile, the U.K.'s trade with the non-EU world saw a 65% rise for goods exported and a 35% increase in services sold abroad between 2006-2012, so the dependence on European markets is slowly diminishing in favour of emerging market countries, North America and Australasia.  

The other factor hampering the U.K.'s cherished rebalancing toward exports and investment is the fact that it's manufacturing base has withered to just over 12% of GDP, though that is slowly recovering. However, manufactured goods contribute just over half of the U.K.'s exports with aerospace and automotive performing particularly well. By contrast, in Germany manufacturing accounts for about 20% of GDP and therefore that country makes a broader range of products to offer on world markets. Indeed, growth areas driven by emerging markets ranging from infrastructure related goods, machine tools through to luxury items have not benefited the U.K. nearly as much as Germany because of the former's much smaller industrial base. Many emerging market countries have not yet grown to levels of prosperity where they require services — an area the U.K. is strong in.

EURGBP chart

Some reasons for optimism

But it's not all doom and gloom. The U.K.'s unemployment rate has been falling and stands at 7.7%, despite cuts in the number of public sector workers. The other factor is that the U.K. has a flexible economy and there is a growing number of start-ups across the country spurring innovation, job creation and should contribute to economic growth. 

GBP's fall against the euro may help exports to healthier parts of the Eurozone, but what's really needed is a recovery in demand in countries such as Spain, Italy and even France and there are tentative signs that some peripheral Eurozone economies might be close to bottoming out.

But whilst this painful rebalancing of the economy takes place, GBP is likely to see prolonged spells of weakness, punctuated by sharp relief rallies in what is otherwise probably a long-term bear market.

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About the Author
Justin Pugsley

Justin Pugsley is the forex and gold markets analyst for New Zealand-based trading platform provider MahiFX. He is a keen student of markets, economics and history. Prior to working with MahiFX, Justin worked for a number of leading media organisations such as Thomson-Reuters and Dow Jones/Wall Street Journal.

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