Can the Northern Ireland protocol deal fix the UK’s trade deficit?

What is the UK’s trade position?

A trade deficit (also called a current account deficit) occurs when a country’s imports exceed its exports. And the UK economy is wrestling a huge one. 

First, some good news. Trade figures released last week showed that the trade deficit narrowed in January, and the sharp drop in wholesale gas prices should see the underlying trade deficit fall further in the coming months. 

But deeper problems remain. Last month, UK exports of goods were 9.4 per cent below their 2018 (pre-Brexit and pre-Covid) levels (see chart). By contrast, exports from all advanced economies were 3.8 per cent above their 2018 average by November of last year. Gabriella Dickens, senior UK economist at Pantheon Macroeconomics, expects the deficit to narrow this year, but remain far above 2021 levels.

Is it a problem?

A current account deficit means that the UK is a ‘net borrower’ with the rest of the world. To finance our current account deficit, we need to attract financial inflows. If we can’t, sterling would have to depreciate enough to close the gap in our external accounts, triggering a so-called balance of payments crisis. 

Last year, economists feared that economic and political upheaval could leave foreign investors less willing to fund the UK’s external deficit. In the wake of the fallout from the mini-Budget, Paul Johnson, director of the Institute for Fiscal Studies think tank, argued that “concurrent large fiscal and current account deficits made markets seriously nervous when big, unfunded tax cuts were announced”. 

Though fears of a current account crisis proved overblown, they haven’t entirely disappeared. Bank of America FX strategist Kamal Sharma warned earlier this year that “the trend deterioration in the UK's external trade position remains a worrying one and leaves the currency vulnerable to the kind of pressure seen in September 2022”.

But at the same time, it is worth noting that an improving balance of trade position isn’t automatically good news: the reason for the realignment matters. Our trade deficit with the EU may well narrow over the coming months if the UK economy deteriorates, reducing demand for European imports as euro area demand for UK goods and services remains strong. When it comes to the trade balance, be careful what you wish for. 

WiIl the Northern Ireland Protocol agreement improve the UK’s trade position? 

On the plus side, it seems likely that the deal will improve the economic performance of some import-intensive businesses in Northern Ireland. But unfortunately, the direct impacts on trade will probably be limited. Analysis from Pantheon Macroeconomics highlights that Northern Ireland accounts for just 2.2 per cent of UK gross domestic product (GDP) (for context, Wales and Scotland account for 3.4 and 7.4 per cent, respectively), meaning that the new deal will not materially change the outlook for UK trade as a whole.

Simon French, chief economist at Panmure Gordon, stresses that frictions to UK-EU trade remain unaffected by the deal, and is sceptical of claims that it could unlock billions of pounds worth of business investment into the UK. Nevertheless, he adds that the deal “reduces the risks facing investors looking to allocate to the UK”, and “represents a more helpful backdrop for capital deepening, a re-rating of UK public companies and upward momentum for the UK pound”. 

French thinks that the potential impact on sentiment could be significant, with the deal representing a transition from the “moaning teenager” stage of negotiations to a “more mature” phase. Economists at Pantheon Macroeconomics also hailed the impact on business confidence, noting that “at least the direction of travel in EU relations is now positive, and businesses have less to fear”.