(The opinions expressed here are those of the author, a
columnist for Reuters.)
By Jamie McGeever
LONDON, June 7 Reports of Britain being on the
verge of a current account crisis are almost always greatly
exaggerated but the second half of 2017 could be the hardest
time for years to convince overseas investors that they should
keep on plugging the yawning deficit.
Economic growth is slowing, Brexit uncertainty will
crystallise as negotiations over Britain's departure from the
European Union get under way, and the relative yields on offer
to foreign buyers of UK gilts are the lowest in decades.
Having one of the developed world's biggest current account
deficits means Britain relies on "the kindness of strangers", in
the words of Bank of England (BoE) governor Mark Carney, to
balance its books.
Last year the deficit was 4.4 percent of gross domestic
product, meaning Britain needed about $100 billion from abroad.
The shock Brexit vote a year ago did not cool demand for
gilts from overseas investors immediately. They kept buying but
demand peaked in November at a three-month rolling rate of
nearly 40 billion pounds ($50 billion) a month. That was the
highest since BoE records began in 1986.
Gilt investors often include foreign reserve managers at
central banks and sovereign wealth funds, with long-term
horizons and deep pockets. They are prepared to ride out
short-term volatility if they see longer-term value.
They are unlikely to cut and run just because of Brexit and
slowing growth. If anything, sterling's 12-percent fall since
June last year will have fuelled more purchases just to maintain
the currency composition of their FX reserves.
But appetite for gilts at any price is not unlimited,
particularly from sovereign wealth managers, who are more
sensitive to rates of return than reserve managers. Since
November, foreign purchases of gilts have waned and the rolling
average for most of this year has been a small net outflow.
State Street Global Markets' EMEA head of macro strategy,
Tim Graf, believes foreign demand is the "swing variable" for
financing the current account. Worryingly, that demand may be
about to dry up, he said.
You can see why. Returns offered by gilts seem low in light
of the potential risks ahead. Official interest rates are a
record low 0.25 percent and the 10-year yield is back below 1
percent, the lowest since October.
The difference between British and the G3 - U.S., German and
Japanese - average 10-year yield is about 17 basis points, close
to the lowest in decades, according to State Street.
Meanwhile, inflation is 2.7 percent - already above the
BoE's 2 percent target - and rising, putting the squeeze on real
earnings, consumer spending and overall growth.
This comes just as the Brexit uncertainty is set to crank up
a level irrespective of the outcome of this week's national
election and break-up talks with the EU begin in earnest.
"The risk is for reduced inflows in the short run and
potential outflows over the long run. That's a worry for me,"
And it is not just bonds. According to Office of National
Statistics data, foreign investors sold a net 60 billion pounds
of UK equities in the fourth quarter of 2016, their biggest
single quarterly sales on record going back to 1980. On a
four-quarter rolling basis the total outflow was 114.5 billion
pounds, also the biggest fourth quarter outflow on record.
Mutual fund flows data from EPFR Global show that cumulative
UK equity fund inflows have evaporated since the start of last
year. Outflows are now the largest for years.
Meanwhile, a report this week by asset manager Invesco
showed that sovereign investors view Brexit as a significant
risk for all UK investments.
The study, based on interviews with 97 sovereign wealth
funds, state pension funds and central banks with assets in
excess of $12 trillion, showed that Britain saw the biggest drop
in attractiveness, scoring 5.5 out of 10 versus 7.5 last year.
Some 41 percent of sovereigns expect to introduce new
underweight positions to UK assets in 2017, compared with just 5
percent planning new overweight positions. A majority of 54
percent said they would not make any changes to their weighting,
preferring to wait to assess the longer term impact of Brexit.
But foreign investors do not need to sell UK assets for
current account funding - and therefore sterling - to come under
pressure. They just need to buy less, or not buy at all.
(Graphics by Jamie McGeever and Andy Bruce; Editing by Louise