J-curve. Noun. Economist jargon.
The shape of the trend of a country’s trade balance following a DEVALUATION. A lower EXCHANGE RATE initially means cheaper EXPORTS and more expensive IMPORTS, making the current account worse (a bigger DEFICIT or smaller surplus). After a while, though, the volume of exports will start to rise because of their lower PRICE to foreign buyers, and domestic consumers will buy fewer of the costlier imports. Eventually, the trade balance will improve on what it was before the devaluation. If there is a currency APPRECIATION there may be an inverted J-curve.
“After a while” being the key point of that sentence. Fast forward to Wednesday’s news on the UK trade deficit:
The trade deficit in goods and services rose to £3.6bn in January from £3.2bn in December, driven by a sharp drop in exports to countries outside the European Union that was not matched by falling imports, the Office for National Statistics reported on Wednesday.
Over the three months to the end of January, however, the trade deficit narrowed to £10.3bn from £11.1bn in the previous three months.
Citing the volatility of monthly data, leading economists expect the trade deficit to continue to contract in the longer-term as a weaker pound helps to support exports, while falling domestic demand — and the higher prices in sterling of foreign goods — reduces imports.
The November – January quarter is now composed of (for goods and services):
- A £4.5bn trade deficit in November, the widest since 1697.
- A £3.6bn trade deficit for December.
- And the £3.6bn for January.
The Bank of England has been trying to competitively devalue sterling to help boost the British economy since circa Autumn 2008. The timing of the J-curve effect aside, there’s another question we should be asking and that is whether the J-curve will work at all in the current economic climate.UBS put it well in a recent note:
In general, UK exporters are price takers. Sterling depreciation thus helps UK exporters…. while the exchange rate will be an important launching pad for UK exporters, the prospects for trade critically depend on global demand. In fact, on our estimates global demand is nearly five times as important as the currency in driving export volumes. – Looking ahead, we expect an export-led recovery in the UK, but for that to happen we need the US and the euro area economies to pick up. We expect that to occur in 2009 H2.So while UBS expects an export-led UK recovery in the second-half of 2009, they think it will be driven by an uptick in US and European demand — not the effect of a weaker pound. While the US/European forecast itself seems optimistic, to say the least, it’s also a valid point. With the abundance of quantitative easing and low interest rates around the world, global currencies are now basically a race to the bottom in terms of value — potentially eliminating the beneficial effects of the J-curve in places like the UK.
Related links:
Trading like it’s 1697 – FT
UK January trade deficit widens to £3.6bn – FT
So what does the UK export? (UBS note) – FT Alphaville Long Room