Political ups and downs leave sterling gyrating

Factory gate prices ease as commodity prices fall
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Another day of political uncertainty helped to push sterling to a one-week low against the dollar, a two-week low against the euro and the yield on 10-year gilts 8 basis points up to 3.92 per cent – the highest since February.

The high drama in Westminster again left sterling gyrating as wildly as some ministerial careers. Sterling fell to $1.5959, compared with a seven-month high of $1.67 seen as recently as Wednesday. The pound was also hit later in the day by a sharp surge in the dollar in the wake of better-than-expected US jobs data. The euro rose to a two-week high of 88.67p before subsiding to 87.48p after the Prime Minister's press conference.

News from the real economy, hugely overshadowed by politics, was mixed: factory gate prices continued their journey downwards, while the Office for National Statistics said that the construction industry shrank even faster than had been thought during the first three months of this year.

The markets seemed unable to make their minds up as to whether the Prime Minister and his Chancellor remaining in post was a good or bad thing. Most believed that the economic fundamentals, especially the pressures on Britain's public finances, would be the dominant influence on sterling, rather than the fate of certain politicians.

Howard Archer, the UK economist at Global Insight commented: "It is clear that the rate of economic contraction is currently slowing substantially. Therefore, it seems particularly important to minimise the uncertainty and ructions facing the economy, and we believe this is best achieved by keeping Mr Darling at the Treasury.

"In the medium and long term, though, we suspect it is not going to make much difference. The Budget has already taken place for this year, and it looks highly likely that there will be a Conservative chancellor by mid-2010 at the latest."

Michael Saunders of Citi European Economics added: "An early change of prime minister could open up other scenarios: the possibility of either an earlier change of government that could produce a quicker shift to serious fiscal restraint; or the prospect of a hung parliament that would make major multi-year fiscal restraint less likely. At the very least, such uncertainties may cause foreign investors to require a higher near-term risk premium on sterling assets." Most welcomed the continuity of having Mr Darling and the Business Secretary, Lord Mandelson, staying in their current jobs.

But the latest producer price data does confirm that cost pressures in the manufacturing sector are continuing to ease rapidly. Input costs and finished goods values – factory gate prices – fell by annual rates of 9.4 per cent and minus 0.3 per cent respectively in May. Both were driven down by plunging commodity prices since their peaks last year and the general weakness of demand in the economy. It means that prices in the shops will continue to fall, and gives the Bank of England more cause to keep interest rates low. The weakness in the economy as it passed through the depths of the recession was clear from the revised construction industry data – which the ONS said could knock 0.3 per cent off its previous estimates of a first quarter fall in GDP of 1.9 per cent.