Currencies: Budget set to end pound/mark rally

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The pound seems unlikely to maintain its recent four-year high against the mark as currency traders switch their focus to the budget, likely to be delivered on 10 June.

This is expected to raise taxes and cut spending - moves which would slow the economy and make further official rate increases unnecessary, hurting the currency.

"We are likely to see sterling start to ease, because Labour are anxious to show their fiscal credentials," said Terence Prideaux, a director of Zurich Investment Management. "That should reduce the strain on monetary policy and is likely to be negative for the currency."

Economists at Goldman Sachs estimate spending and tax measures the government is contemplating may shave 0.5 per cent off gross domestic product in the current financial year. That would be equivalent to a 1 percentage- point rise in interest rates, alleviating most of the need for higher rates this year.

The pound shot up almost three pfennigs to 2.836 marks after Gordon Brown gave the Bank of England free rein in setting interest rates.

Since then, though, sterling has stumbled and fell as low as 2.7125 marks last Monday.

"One thing is certain - tighter fiscal policy will take the pressure off monetary tightening," said Edmund Nonas, UK economist at Nikko Europe. "Sterling should stabilise around 2.70 marks in the coming weeks and fall further in the months ahead."

Some of the tax increases are already known. The windfall tax was a central pledge in Labour's election manifesto but it is still unclear how much the tax will raise. Analysts expect anything between pounds 3 billion and pounds 5 billion.

The government has also announced plans to raise pounds 1bn over 10 years by increasing fees for users of radio frequencies such as mobile phone users and taxi companies, and some analysts expect Labour to reduce tax breaks for mortgage payments, raising about pounds 800 million.

Labour has also pledged to match spending cuts planned by the Tories in the next two years. If achieved, this would reduce the government's deficit to 1.0 per cent of gross domestic product by March 1999.

The pound got a lift when the Bank of England said in its quarterly inflation report last Tuesday that there's a need to raise official rates to keep inflation within the government's target.

Yet the central bank also said it will take into account any new taxes raised by the government, when deciding base rates.

That's got investors speculating that Labour's fiscal plans will snuff out the pound's nine-month long 20 per cent rally against the mark.

"For all intents and purposes, the rally is over," said Tony Norfield, the treasury economist at ABN AMRO-Hoare Govett. "The policy balance in the UK is going to be negative for sterling." Copyright: IOS & Bloomberg