UK BALANCE OF PAYMENT

UK Balance of Payment

UK Balance of Payment

Introduction

Today sees further economic updates which will tell us a little more about the state of the UK economy. These are the British Retail Consortiums (BRC) update on retail sales in February and the balance of payments figures for January 2010. Taking the retail sales figures first we saw the following according to the BRC. UK retail sales values rose 2.2% on a like-for-like basis from February 2009, when sales had dropped 1.8%, hit by snow and consumer caution. On a total basis, sales rose 4.5% against only 0.1% growth in February 2009. So in comparison with a poor February in 2009 we did a little better and if anything it adds to the data indicating a weak recovery in the UK. (faculty.washington.edu)

Discussion of the Article

We am particularly interested in the trade figures because there has been some hope of improvement because of the depreciation in the UK exchange rate. Now it is not the fall over the last month that concerns me because it will take time to have an impact but more the depreciation that took place in 2007/08. Using the monthly average for the Bank of England's effective (trade-weighted) exchange rate then we had a peak of 105.45 in January 2007 and which then fell over time to 76.64 in March 2009 giving us a fall of 27.3%. As you can see there was a substantial fall and economic theory would indicate that an improvement in the UK trade balance should result. Also in case you are wondering this fall was followed by a small rally in our exchange rate but our effective exchange rate is 77.03 as of Monday nights close.

J Curve

The reason for the delay is called the J curve in economics. What this means is that a country's trade deficit will worsen initially after the depreciation of its currency because higher prices on foreign imports will be greater than the reduced volume of imports. However as time goes by this will be replaced by a longer and hopefully more permanent effect where the effects of the change in the price of exports compared to imports will eventually induce an expansion of exports and a cut in imports-which, in turn, will improve the balance of payments. (faculty.washington.edu)

Other Effects and imported inflation

An even longer term effect is where a country benefits from the J curve but where the depreciation causes an increase in prices and then inflation which is often called “imported inflation”. This is a particular concern for the UK over this period as we have fallen heavily against the US dollar over this period and so many commodities and raw materials are priced in US dollars. So these commodities will be relatively more expensive. Accordingly for a depreciation to be successful in the long-term the country has to have a low inflation rate and specifically keep its inflation at the rate or better still lower than its trading ...