The pound may look vulnerable, but the UK is not alone Sterling is set for a white-knuckle ride in the run-up to the general election, as the fiscal face-off between the Conservatives and Labour keeps the UK's hefty deficit in the headlines, and investors fret about the consequences of a hung parliament. News on Friday that GDP expanded more rapidly than first thought at the end of last year – by 0.3% in the final quarter, instead of the 0.1% early estimate – failed to lift the embattled pound, which at one point hit its lowest level for nine months against the dollar. Analysts say foreign exchange markets are likely to keep up the pressure on sterling, until they see the detailed tax and spending plans of whatever government takes power. "In the run-up to the election, the fact that the fiscal position is going to be highlighted is probably a drag," said Dhaval Joshi, head of strategy at RAB Capital. He argues that while the UK is far from the only country wrestling with a deficit, sterling has an Achilles heel – the heavy reliance of equity and bond markets on foreign cash. Almost half of the UK's equities, 46%, are owned by overseas investors, compared to just a quarter of the US market. In the bond markets – which could be a critical gauge of confidence now quantitative easing is being withdrawn – more than half of the market is in foreign hands, once corporate bonds as well as gilts are taken into account. That compares to just a quarter in the US (see charts). In the good times, the prevalence of foreigners on the UK's share registers was taken as an impressive symbol of a globalised economy. But, as Joshi points out, it makes the currency especially vulnerable, because if overseas investors want to withdraw funds and plough them into a different market, they will also have to exchange their pounds for another currency. He doesn't believe that makes a "sterling crisis" inevitable – but it does create a worst-case scenario in which the FTSE drops because investors fear a worldwide "double dip" while a decisive plan for public finances is stymied by a hung parliament, leading to UK bonds being singled out for a sell-off. Both of these could put intense downward pressure on the pound. Danny Gabay, director of economics consultancy Fathom, says the UK has in effect already had a sterling crisis: the pound is about 25% lower against the currencies of major trading partners than before the credit crunch. Contrary to policymakers' hopes that the depreciation should rebalance the economy by boosting exports, he warns that the weakness ofEurope's economy means demand is likely to be stagnant. "We and Europe are now both on course for a flat-to-negative first quarter. If Europe has stalled, then to whom and to what are we meant to export?" He believes that as the UK struggles to emerge strongly from recession, the pound will come under further pressure. Not everyone is convinced by that argument, however. David Bloom, head of foreign exchange strategy at HSBC, says although attention is likely to focus on the UK in the weeks running up to an election, there are plenty of other countries facing their own crises. "This is the classic schoolboy error of ignoring the difference between an absolute problem and a relative problem. Who are we going to have a crisis against – Greece? The eurozone? Dubai?" he says. "You have to imagine a scenario where the UK has an independent problem that no one else has." Like Bank of England governor Mervyn King, who has played down the parallels with Greece, Bloom argues that any party winning a majority is likely to announce firm plans for bringing the finances back under control. "Let's face it, we have got a fiscal problem, but we've got a big tax base and we'll sort it out," he said. He describes what happened in the financial markets over recent months as a "rotating sovereign debt crisis". The recession of the past 12 months has been worldwide and, with interest rates at rock bottom in many countries, governments have been forced to dig deep to offset the worst effects. Investors focus for a short time on one government that is struggling, then switch their attention to the next potential victim. For the next few weeks, as the parties engage in a slanging match about public finances, the pound may be the whipping boy. But Bloom reckons once the election is out of the way, attention will turn to another large economy with a devastated financial sector, a spiralling budget deficit and an election in the offing: the US, where the state of the public finances is likely to be a key issue in the November mid-terms.Sterling faces pressure as election looms, but who's next?
Sunday, 28 February 2010
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