Profile of United Kingdom’s Pound – Overview of Economy

Profile of United Kingdom’s pound – overview of economy

This lesson will cover the following

  • A look at UK economy
  • The case with adopting the euro
  • Monetary policy authority – Bank of England

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Economic overview

The United Kingdom is the sixth largest economy worldwide with a nominal GDP of 2.54 trillion USD in 2013 and also the eighth largest economy in terms of GDP measured by purchasing power parity (2.39 trillion USD), according to the International Monetary Fund. Nation’s nominal GDP per capita is the 23rd largest in the world (39 567 USD in 2013), while its GDP per capita measured by purchasing power parity is the 22nd highest (37 307 USD in 2013). In 2012 the country had the 3rd largest stock of received Foreign Direct Investment (1.321 trillion USD, according to CIA World Factbook) and the second largest stock of Foreign Direct Investment abroad (1.808 trillion USD).

UK servicesUnited Kingdom’s economy is service-oriented, with services sector accounting for around 77.8% of the GDP as of the first quarter of 2014. Nation’s financial services industry added gross value of 116 363 million GBP to economy in 2011, according to the 2013 Blue Book report. The city of London is renowned as one of the three command centres of international economy alongside New York and Tokyo.

London is a leading centre for industries such as banking (over 500 banks have their offices based in UK’s capitol), insurance, foreign exchange and energy futures trading.

northseaoil_1797523bUnited Kingdom is among the largest producers and exporters of natural gas in the European Union. In Europe the United Kingdom is second largest oil and gas producer following Norway. In 2008 the country produced 549 billion barrels of oil and 68 billion cubic metres of natural gas. This way over three quarters of UK primary energy demand for oil and gas was met. In 2010 the country produced 60% of the gas it consumed. As energy production comprises over 10% of the GDP, any increase in prices of energy products boosts opportunities for a number of oil exporting companies in the UK, for example. The country was a net oil importer for a short period because of disruptions in the North Sea back in 2003, but has already recovered its status as a net exporter of oil.

UK’s sector of manufacturing added gross value of 140 539 million GBP to economy in 2011, with 2.6 million people being employed in the sector. Mining industry, on the other hand, added gross value of 31 380 million GBP to economy during the same period.

As far as UK international trade is concerned, seasonally adjusted deficit on UK’s trade balance was reported to have shrank to 1.3 billion GBP in March 2014, according to the Office for National Statistics, from a deficit of 1.7 billion GBP during the prior month. In 2013 exports amounted to 503.6 billion USD, while imports were 529.5 billion USD.

According to www.statista.com in 2012 United Kingdom’s largest export partners were: Germany (with a share of 11.3% of total exports), the United States (10.5%), Netherlands (8.8%), France (7.4%), Ireland (6.2%).

At the same time, in 2012 nation’s largest import partners were: Germany (with a share of 12.5% of total imports), China (8.2%), Netherlands (7.1%), the United States (7.0%), France (5.7%).

The case with adopting the euro

adopting the euroThe United Kingdom refused to adopt the euro in June 2003. If the country had joined the European Monetary Union (EMU), this would have considerable consequences for the economy. Interest rates in the UK would need to be adjusted to the equivalent interest rate in the Euro zone. As the UK policymakers are highly concerned with voter approval, in case the vote does not favor the adoption of the euro, an entry in the EMU is not very likely. There have been a number of opinions in favor and against the adoption of the single currency.

Those, who supported the idea, gave the following arguments:

First, this would diminish the exchange rate uncertainty for UK business sector by lowering exchange rate transaction costs and risks;

Second, a common currency is related with increased price transparency;

Third, sustaining low rates of inflation by the European Central Bank would lead to a decrease in long-term interest rates and would spur growth;

Fourth, the euro has a status of the second most vital reserve currency following the US dollar;

Fifth, integrated national financial markets in the European Union would cause capital to be allocated in Europe more efficiently.

Those, who confronted the idea, also gave their arguments:

First, currency unions had not been that stable in the past;

Second, strict EMU criteria are proposed by the Stability and Growth Pact;

Third, disturbances in economic and political systems of one nation would certainly have their influence on the common currency and this would also hurt sound economies;

Fourth, an EMU entry would mean a transfer of local monetary authority to the European Central Bank (ECB), while concerns appeared over which nations might have dominance over the bank;

Fifth, becoming a member of a currency union, which lacks monetary flexibility would certainly require the United Kingdom to have more flexible housing and labor markets.

Monetary policy authority – Bank of England

If the Bank of England sets a negative interest rate, it could encourage lending.Founded in 1694, Bank of England’s main objective is to maintain monetary (stable prices and confidence in the national currency) and financial stability. Stable prices are determined by central bank’s inflation objective, which it strives to meet by decisions made by the Monetary Policy Committee (MPC). The Committee sets the benchmark interest rate, which according to the MPC, will facilitate the accomplishment of the inflation objective. The Committee is comprised by nine members – one Governor, three Deputy Governors, the Bank’s Chief Economist, one Executive Director for Markets and four outside members, appointed directly by the Chancellor. The MPC’s decision is taken on the basis of “one person – one vote” and not on a consensus of opinion. The decision reflects the votes of each individual member of the Committee. The CPI inflation target is set to 2%.

The MPC conducts policy meetings every month, which are very closely watched by market players for changes in monetary policy, including the base interest rate (repo rate). The Committee releases statements following every meeting, as well as its quarterly Inflation Report, which provides a detailed information regarding bank’s forecasts on growth and inflation during the next 2 years.

BoE also releases its Quarterly Bulletin, which reflects monetary policy decisions in the past and also gives insight on international economic conditions and their influence on United Kingdom’s economy.

repo-rateBank of England uses two main policy tools – the repo rate and open market operations. The repo rate is the interest rate, at which BoE lends to financial institutions in the country. This rate influences a whole range of interest rates set by commercial banks and other institutions, offered to their own savers and borrowers. The repo rate tends to have influence also on the price of financial assets (bonds and stocks) and the exchange rate, which affects consumer and business demand. Adjustment of the repo rate impacts spending and output in the UK. Raising borrowing costs means an attempt to ease high rates of inflation and lowering them means an attempt to spur economic growth (saving becomes less attractive and borrowing becomes more attractive and, thus, the willingness to spend increases).

We thoroughly discuss open market operations in our Forex Trading guide.

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