Weak Sterling facing the perfect storm

News - Banking

Written by Ray Clancy

Thursday, 04 March 2010 09:55

Sterling is facing a perfect storm brewed up by UK debt, political uncertainty and concerns that more money will have to be injected into the economy by the Bank of England, it is claimed.

As a result the outlook for the currency is extremely volatile and it is likely to remain so until the outcome of the country’s general election which is expected sometime in May.

In recent days Sterling has been falling against all the major currencies including the dollar, euro and the yen.

Political and economic worries, combined with the currency impact of Prudential’s purchase of AIG’s Asian insurance business, will weigh heavily on sterling, according to Nick Beecroft, senior forex consultant at Danish bank Saxo. The firm provides private clients with currency trading platforms.

‘Sterling has sailed into a perfect storm of negativity. Not only is it assailed by political uncertainty as the Conservative Party poll lead evaporates, raising the ugly spectre of a hung Parliament with Labour forming the largest party, but it also has to contend with Prudential's monster $35 billion acquisition of AIG's Asia operation, AIA,’ Beecroft said.

He said that the Bank of England remains bearish on the UK economy, leaving open the need for more injections of money into the system, traditionally a recipe for an eroding currency.

‘Cranking up the printing presses would accelerate the pound’s collapse, but the market is coming to suspect that this is the plan given the unavoidably tight fiscal stance that any incoming government will be forced to adopt. Maybe the powers that be are adopting the classic solution to a debt mountain, devaluation, spurred on by an ultra-loose monetary policy,’ Beecroft added.

Jeremy Stretch, a currency strategist at Rabobank International, said that ‘sterling is being seen in the risk bucket and risk is off the agenda right now. Investors are taking bets on rate hikes off the table’.

The UK government is selling a record amount of debt to finance fiscal stimulus measures designed to help the economy recover from the longest recession ever recorded. ‘We’re very, very aware of the risk the UK is carrying. Debt is a horrible thing. Sterling is a very vulnerable currency,’ said Bruce Stout of Murray International Trust.

‘The markets need convincing that UK debt can be reduced. But as the pound drops, the currency markets appear to have run out of patience. Sterling could be staring over the edge of the abyss,’ said Mark O’Sullivan of Currencies Direct.

Some investors fear that a hung parliament and minority government would lead international credit ratings agencies to downgrade Britain’s status as a low risk borrower, making it more expensive for the government to raise funds.

‘As we face down a period of severe fiscal tightening with higher taxes and public spending cuts, consumers remain very concerned over the security of their jobs and economic future. Credit conditions also remain very tight as the banks keep tight controls over lending to both consumers and businesses,’ said Mark Bolsom, Head of the UK Trading Desk.

The slide in sterling comes at a time when currency volatility, driven by the financial crisis, has put foreign exchange trading high on the agenda of many wealth managers. With weakness across many leading currencies enduring and volatility set to rise in 2010, various strategies are being employed to mitigate the impact on the value of clients’ portfolios. This is of particular concern for clients with investments outside of their base currency or with international interests.