City shocked as trade balance lurches further into the red

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Britain's trade with the rest of the world swung unexpectedly further into the red in March, according to the latest figures from the Office for National Statistics. In a shock to City economists who had expected the improvement seen in recent months to pick up speed, the deficit on goods instead lurched to £7.5bn, from £6.3bn in February.

Imports, despite the slowness of the recovery, were robust, up by 5.2 per cent in value terms; exports were anaemic – a mere 1 per cent up. In volume terms, imports were up 3.5 per cent and exports fell by 1.8 per cent.

Adding in the service sector, the overall trade deficit widened from £2.2bn to £3.7bn.

Surveys of business confidence in manufacturing suggest that export order books are filling up and should feed through to a better performance over the next year. The volume of semi-manufactured goods, to be finished in the UK, and raw materials imported in March also suggests a prospective improvement. The ONS also pointed to a hold-up in exports reaching the ports after January's cold weather slowed production. However, after a 25 per cent depreciation of sterling since its peaks in 2007 the UK's trade performance will be seen as disappointing, and possibly indicative of more serious underlying issues of competitiveness. Much of the burden of exporting falls to the industrial sector, though it only now accounts for about 17 per cent of the economy.

The figures came the day after the Governor of the Bank of England, Mervyn King, stressed once again the need to rebalance the economy from consumption at home towards exports. The sheer scale of the economic challenge facing the new coalition Government has been dramatically underlined by this data.

Observers have expressed concern about where the next "growth story" for the economy will emerge to replace the previous engines of the City, housing and public spending. Vicky Redwood, senior UK economist at Capital Economics , said: "It still seems unwise to rely on the external sector to keep the economic recovery going once the fiscal squeeze hits."

The fall in the value of the pound has, meanwhile, helped to feed a surge in inflation, now at 3.4 per cent, and well above the official target of 2 per cent. Some at least of the benefit of the depreciation has been taken by exporters in the form of higher profit margins, maintaining their foreign currency pricing rather than attracting more sales through sharper prices.

An even more potent medium-term concern is the financial crisis in the eurozone, Britain's largest export market. The crisis threatens to undermine confidence, and the recent slide in the value of the euro is also undoing some of the depreciation in sterling. Alan Clarke, the economist at BNP Paribas, added: "This highlights again that although the weakness of the pound improves competitiveness, unless this is accompanied by an expansion in overseas demand, then there will be little if any improvement in the performance of exports. With the eurozone, the UK's main trading partner, still sluggish, exports are unlikely to surge any time soon.

"Net exports are one of the greatest hopes for growth this year and next given the improvement in competitiveness associated with the pound. Thus far, all the weakening in sterling has brought is inflation, and we are still holding our breath for the long-awaited boost to growth."