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Sterling Slides on Election Worries

02 March 2010 04:31 (UTC +04:00)

Baku â€“ APA. The pound suffered its worst drop in months, as uncertainty about looming national elections combined with persisting economic problems to spook investors already nervous about the U.K.’s ragged fiscal situation, APA reports quoting â€œThe Wall Street Journalâ€.
The pound skidded early Monday in Europe, at one point falling 3% against the dollar to $1.4784â€”its lowest level since April 2009â€”before recovering to finish at $1.4973 in London, down 1.2% from Friday. Sterling is down 7.3% against the dollar this year, and negative sentiment has increased sharply in the past week. Monday’s mid-morning fall was the biggest single-session drop in nearly a year, Bank of New York Mellon said.
Investors have focused heavily on the euro’s problems since Greece’s fiscal difficulties surfaced late last year. But the euro, down 5.4% against the dollar this year, has held up better than the pound. While Greece faces tough funding challenges, other members of the euro zone, notably Germany, are in strong enough shape to give Athens assistance should it be required.
The U.K. has no such rich relative to help it. Moreover, its fiscal situation has become a double-edged sword, with tensions around the deficit growing as the national election, due by June, approaches. Some market commentators argue that the U.K. must swiftly reduce its deficit to placate restless bond investors who are concerned about the possibility of the fiscal situation eroding even more.
At the same time, analysts at Swiss bank UBS AG recently warned that sterling could fall to $1.05 or even lowerâ€”if Britain moves too aggressively to cut the deficit. Being too quick to cut spending could shove the economy back into recession, UBS said. Fourth-quarter gross domestic product had a meager gain of 0.3%, heavily supported by government spending, so the fiscal debate remains a sticking point.
"You’ve got negative economic surprises, negative political risks and negative capital outflows," says Monica Fan, a currencies portfolio manager at investment firm State Street Global Advisors in London. "Investors who are concerned about the possibility of a Greek default are increasingly eyeing the U.K.’s high level of public debt and public deficit as a reason to sell sterling."
Ms. Fan’s reference to capital outflows referred in large part to insurer Prudential PLC’s plan, unveiled Monday morning, to acquire American International Group’s AIA business for $35.5 billion, $25 billion of it in cash. U.K.-based Prudential will need to convert a large amount of sterling into dollars to make the acquisition, something that investors said amplified negative sentiment around the pound.
The political debate has also turned darker now that the quagmire that would be caused by a hung Parliament is considered a realistic possibility after the coming elections.
In such a scenario, the winning party still doesn’t have sufficient Parliamentary support to carry out its legislative agenda without help from other parties.
David Cameron, the leader of the opposition Conservative Party, has watched the disintegration of his once double-digit lead in opinion polls over Prime Minister Gordon Brown’s ruling Labour Party. On Sunday, a YouGov poll for the London Sunday Times placed the Conservatives just two points ahead. That is among the slimmest of Tory leads since Mr. Brown enjoyed a brief honeymoon period after he took over from Tony Blair in June 2007.
Because of the way the U.K.’s voting system works, most commentators believe the Conservatives need a 10-percentage-point national lead to be confident of commanding a parliamentary majority. Failing that, the result could be the election of Britain’s first minority government in three decades.
The postelection stakes are large. International credit-ratings agencies have warned the U.K. it could lose its top-notch triple-A rating if the winner of the next election fails to offer a credible plan for fixing the nation’s finances.
Any new government plan must address what looks like a still-fragile national economy.
Economists and traders have started rifling through the speeches of the smaller British parties, since they could hold the key to crucial votes on budget matters. The Liberal Democrats, the country’s third-largest party, is seen as the most likely king maker.
The Conservatives have pledged to start cutting spending this year, whereas Mr. Brown’s Labour has said such a stance could undermine the nascent recovery.
Labour also has promised to protect more government departments from cuts. The Conservatives have given limited details of how they would reduce the deficit, and occasionally have appeared to contradict themselves on when any austerity measures would get under way.
Many analysts are taking politicians at face value when they say that they understand the gravity of the deficit and will act accordingly.
"Both sides recognize that something will have to be done quite quickly to avoid a downgrade," says Kevin Gardiner, the head of investment strategy at Barclays Wealth.
As political concerns grow, Britain’s economic data show the challenges it faces. The U.K. has lagged behind the U.S., Germany and France in bouncing back from the financial crisis. Some economists think the Bank of England may need to restart its quantitative-easing programâ€”buying government bonds with newly created moneyâ€”to pump cash into the economy, a move that would further burden the pound.