GBP - Sterling | Pound faces Big Test in 2010

Sterling faces stern test in 2010

By Peter Garnham
 

Sterling
All change: Sterling is off 29 per cent against the euro since the onset of the financial crisis in September 2007

Sterling could be in for a testing 2010, with some analysts predicting it could finally hit parity against the euro.

The UK currency is expected to continue to feel the impact of the financial crisis - but it also has to negotiate a general election which could lead to a hung parliament and a big rise in political uncertainty.

Sterling has fallen 23 per cent in trade-weighted terms and over 29 per cent against the euro since the onset of the financial crisis in September 2007.

Michael Hart at Citibank says the UK economy shares many of the unwelcome characteristics of the US economy, which was at the epicentre of the crisis.

Like the US, the UK has a prominent and over-extended housing sector, a debt-financed, consumption-driven economy and a widening external deficit financed with income from foreign investment.

Analysts warn that the pound is set to lurch lower as the emergency measures put in place to fight the financial crisis are withdrawn, the cost of those measures begins to become apparent and political uncertainty in the UK heightens.

Ashraf Laidi at CMC Markets says "liquidity withdrawal" may become the buzz phrase of 2010 and the UK economy and its currency could fall victim to an excessive reduction in stimulus.

He says the Bank of England has already signalled that it does not intend to increase its quantitative easing measures any further while the UK Treasury is planning spending cuts and the general election promises to be a close race.

"None of these developments are set to favour the pound or the UK economy which has yet to recover from recession," says Mr Laidi.

"Sterling risks regaining its status as the whipping boy of FX in 2010 as these vital dosages of oxygen are removed from a still tepid economy."

The biggest challenge facing the pound, however, is the UK's fiscal position, including a large budget deficit and rising national debt.

The UK government expects to borrow an additional £707bn over the next five years. As a result forecasts suggest that by 2013-14 the national debt will reach around £1,500bn – or just over 90 per cent of GDP.

"Our reasons for disliking the pound are simple enough," says Simon Derrick at Bank of New York Mellon.

"At the heart of our argument remains the simple question of where the money will come from to fund the nation's projected fiscal deficit in the years ahead."

Mr Hart says once the UK's triple-A sovereign debt rating comes under threat, gilt yields are set to rise sharply and take fiscal policy out of the UK government's control.

He says unless the UK general election heralds a political sea-change, the UK's fiscal situation is likely to continue to deteriorate, resulting ultimately in a credit rating downgrade.

Mr Hart says the UK current account is also a weak point.

This partly reflects the diminished net income the UK earns from its overseas investments, suggesting a structural transformation of the economy that requires a permanently lower exchange rate.

"We expect the pound to drift towards parity against the euro in the next six months," he says. The pound almost reached parity with the euro at the end of 2008 when the euro was worth £0.9803. Sterling recovered in 1999, leaving the euro at £0.8878 at the year end.

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Article Reference: http://www.ft.com/cms/s/0/f73a56ea-f6dd-11de-9fb5-00144feab49a.html?nclick_check=1

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