UK's external position weakens amid strong pound: IMF

The UK’s current account (CA) deficit widened to 2.7 per cent of GDP in 2024, underscoring structural imbalances in its external sector, according to the IMF’s External Sector report.  

The cyclically adjusted CA remained at the same level, implying a negative gap of 2.4 percentage points relative to the External Balance Assessment (EBA) norm of –0.3 per cent. After accounting for domestic policy distortions, IMF estimate a residual gap of –1.7 per cent.

The real effective exchange rate (REER) appreciated by 4.2 per cent in 2024 compared to 2023 and is now 10 per cent stronger than its pre pandemic average, eroding price competitiveness. The strengthening was driven by a higher nominal effective exchange rate (NEER), as UK interest rates remained above those of other advanced economies. Elevated domestic inflation also played a smaller contributory role. As of March 2025, the CPI-based REER stood 2.6 per cent above the 2024 average.

The IMF’s EBA models estimated the pound’s overvaluation in 2024 at between 1.5 and 8.7 per cent, with staff assessments converging around a 6.5 per cent overvaluation using an elasticity of 0.26. This appreciation partially reverses the pre-2019 REER depreciation that followed Brexit-related uncertainty.

Despite the widening CA deficit, capital inflows—particularly in the form of portfolio investment in debt—helped finance the gap. However, these inflows were partially offset by increased direct investment outflows. The UK’s status as a global financial centre brings inherent volatility to its capital flows, largely driven by intragroup bank transactions. While this volatility poses potential risks, the Bank of England’s Financial Policy Committee (FPC) continues to monitor systemic risks through a robust macroprudential framework.

Foreign exchange (FX) reserves remain low relative to standard adequacy metrics, but the UK maintains a free-floating exchange rate regime. Sterling’s share in global reserves has increased modestly from an average of 4.5 per cent during 2016–2019 to around 5.0 per cent in 2024. FX reserves experienced minimal drawdown through the year.

ALCHEMPro News Desk (HU)