Hamish McRae: Only an amber alert when Britain's in the red

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The broad pattern of our current account since the late 1960s seems to have been broadly maintained

The broad pattern of our current account since the late 1960s seems to have been broadly maintained

The current account deficit has widened again: should we worry?

To any Briton who remembers the anguish that we used to suffer as a result of a balance of payments deficit the news will engender a slightly uneasy feeling. During the fourth quarter of last year the current account came in at minus £7.6bn, a new record, and about double the number the market expected. The figures may come to be revised because the statisticians frequently find more income than they expected. Indeed, if the deterioration was really as large as that, there would probably have been more sterling weakness than was evident. Still, for last year as whole, it looks as though the deficit will be more than 2 per cent of GDP.

That is not red alert territory by any means; it is only half the level of the US and people do not seem too worried about that. Nevertheless it needs to be watched.

The general background to this is shown in the two graphs. Over the last 40 years there have been three periods when the current account has proved really alarming: one was in 1967 when sterling was devalued, a second in 1973 at the time of the first oil shock, and a third during the Lawson boom in 1988. What about the time of the 1976 IMF loan? Well, when the figures were finally added up, it turned out that things were not so bad – the problem had been more one of lack of confidence in the government than actual economic performance.

Seen in the context of either the early 1970s or the late 1980s there really seems little problem – and the experience of the 1960s was under a fixed exchange rate regime. The fact that the economy is growing relatively quickly by comparison with other large economies, a welcome sign, would tend to widen the deficit. Indeed part of the reason for the sudden deterioration in the fourth quarter was the result of a big swing in interest, profit and dividend payments. Our foreign income slumped (reflecting poor performance abroad) while our payments to other countries boomed (reflecting the better performance here). Yes, I know the latest estimate of fourth quarter GDP is still flat, but wait a while – my guess is that when the figures are finalised in two or three years' time, they will find there was some net growth.

In any case the broad pattern of our current account since the late 1960s seems to have been broadly maintained. For most of the time our trade in goods has been in the red – the surplus was only for brief periods such as the late 1970s when home demand was restricted and the oil price shot up. On the other hand services income, which includes interest and dividends, has been solidly in the black. (The Government, also included in services, is consistently in the red but the private sector surplus more than covers this.)

Still, there is a deficit and there will be a temptation to deduce from this that sterling is overvalued. The trouble with this argument is the "overvalued against what?" question.

It certainly is not against the dollar, for we are in surplus in our trade with North America. Against the eurozone there is a small trade deficit but this is small. It has run consistently for the past 10 years at between 0.25 and 0.75 per cent of GDP. The really big trade deficit is with other countries, in particular emerging East Asia and Japan. We cannot of course devalue against them without devaluing against the rest of the world.

Indeed we probably cannot devalue at all: rather the reverse. One of the quite likely scenarios in the coming months will be a strengthening of sterling in response to our relatively good growth performance and the growing evidence that interest rates here will soon be moving up again.

We may even find ourselves pushing rates up faster than the US and Europe. Merrill Lynch thinks so, having expected for some weeks that rates would move from 4 per cent to 5 per cent in the second half of the year. Barclays now reckons there is a 60 per cent chance the monetary committee will move rates to 4.25 per cent in May. The US will presumably start moving rates up about the same time, though of course from the much lower base of 1.75 per cent. But the European Central Bank may be slower in responding, particularly since it has to reconcile the very different needs of the different parts of the eurozone. Germany does not need higher interest rates at the moment, for despite the signs of a revival of export orders, domestic demand remains slack.

This could be quite tricky for Britain. We need a reasonably strong pound to curtail inflationary pressures here but we do not need an over-strong one. There is the danger that sterling will start to nudge up and block any narrowing of the current account deficit. The evidence seems to be that a gap of anything below 2 per cent of GDP is easily financed by capital inflows, but were that to rise above 3 per cent we would be moving into what on past experience has been the danger zone.

In addition, we have to factor in the uncertainties generated by a referendum on the euro. There is still the general assumption in financial markets that were we to move towards joining it would have to be at a lower level than the present one. Some of us disagree with that and it may well be that the market perception of the appropriate rate will change. But it may not.

The irony, of course, is that were Britain to adopt the euro none of us would care about the balance of payments, just as no-one cares whether California has a surplus or deficit with the rest of the US – or Scotland with England.

The whole calculation would become redundant, if it were made at all. We could buy as many BMWs as we wanted to without feeling guilty that someone else had to earn all that foreign currency to pay for them. Meanwhile, however, the current account remains a useful gauge of the pressures of inflation and demand on the one hand, and on the other, the willingness of people in other countries to invest in Britain. Those latest figures suggest that the warning light is flashing amber. But that is nothing new, is it?

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