Is sterling heading for a fall?

Declining corporate profitability growth in the UK compared with rising profit growth elsewhere suggests the UK will lose out in the global competition for investments. This will show in foreign direct investment (FDI), as slow profitability growth will reduce return expectations on investment.

Net FDI and portfolio inflows into the UK are still rising, explaining current sterling strength. However, it is bond-relative inflows keeping these figures positive, and bond inflows have now declined.

Weak corporate profitability suggests declining bond inflows are unlikely to be compensated by FDI or equity-related inflows. As the current account deficit is unlikely to shrink significantly in coming years, the UK will find it increasingly difficult to fund external deficits. Corporate profitability might even move FDI into negative once sterling-based investors recognise the higher return abroad. PPP overvaluation suggests competitiveness might soon be an issue and the weakening profitability trend indicates funding conditions will weaken. Similarities to 1992 are evident. n