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The relationship between UK current account deficit and EUR/GBP exchange rate

Stefano Fugazzi (ABC Economics) reports

As noted in the July issue of ‘The World of ABC Economics’, Britain’s current account deficit (see Note) has been a cause of concern for many economists who have been trying to project the value of the pound.

The graph below shows how the level of current account deficit in Britain is susceptible to exchange rate movements.

Current account deficit and EUR/GBP. ONS data plus ABC Economics projections (dotted red line).

Current account deficit and EUR/GBP. ONS data plus ABC Economics projections (dotted red line).

Note – How the current account works

The current account can be expressed as the difference between the value of exports of goods and services and the value of imports of goods and services. A deficit then means that the country is importing more goods and services than it is exporting—although the current account also includes net income (such as interest and dividends) and transfers from abroad (such as foreign aid), which are usually a small fraction of the total.

An importer would have demand for the currency of the exporting country. If we look at the UK’s trade balance we can see the UK is clearly a net importer, implying that Britain has a greater demand for foreign currency than does its counterpart which would mean the value of the currency must ultimately fall according to principles of supply and demand.




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