It was political rather than purely economic concerns that pushed sterling to a 10-month low against the US dollar yesterday.
Polls over the weekend strongly indicating that the next general election will result in a hung parliament weighed heavily on markets concerned that a new government will lack the necessary mandate to implement a tough new budget and a long-term plan to tame the deficit.
Sterling finished a shade below the psychological barrier of $1.50, having lost 4 cents. The slump comes after months of concern about the state of the UK's public finances from the credit rating agencies and international bodies such as the IMF and the Bank of England. All have called for a "credible" plan to reduce the state's borrowing, which will be close to 13 per cent of GDP; the more extreme have talked of a Greek-style crisis and described the gilts market as sitting "on a bed of nitroglycerine".
The pound finished at $1.4991, and dealers were not optimistic about the chances of a bounce back. Against the euro, sterling fell to a four-month low of 91.5p, and some market participants speculated about a sub-euro pound before too long.
Mark O'Sullivan, director of dealing at the foreign exchange firm Currencies Direct, said: "Although sterling rallied on the back of the weekend's speculation over a possible bailout of Greece, hitting a high of $1.52 in Asia, reality has now set in. A bailout of Greece would leave the UK extremely vulnerable with its huge level of debt, a fact which our politicians seem determined to ignore. The markets need convincing that UK debt can be reduced."
Adding to the political uncertainties dogging sterling, the latest economic data compounded anxieties. The Bank of England warned that mortgage approvals were down by 17 per cent in January compared to December and at their lowest level for eight months. That boosted fears that the UK's housing market recovery may now have stalled, with Nationwide warning last week that prices have begun falling.
The gilts market was also depressed, and is perhaps starting to miss its biggest buyer, the Bank of England, which has purchased some £200bn of gilts over the past year. The UK gilt/German bund spread – an indicator of the risk markets attach to Britain's debts – rose to almost 100 basis points, roughly equivalent to that demanded for Italian government paper. Italy enjoys an A+ rating on its debt, compared with the UK's AAA, suggesting that the markets have already priced in a ratings agency downgrade.Reuse content