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Sterling suffers fresh battering

Political worries following the defeat of the Conservatives in the Perth and Kinross by-election gave the pound another torrid day on the foreign exchanges. It closed more than 3 pfennigs down at 2.2140 against the German mark, compared with the previous night's close, and the trade-weighted index also fell sharply from 84.9 to 84.0.

Neil Mackinnon, chief currency strategist at Citibank, said the latest fall in the pound was another manifestation of "sterling's well known political sensitivity". Earlier this month, the Bank of England revealed that foreign investors had made large net sales of gilts in the first quarter of the year, "with some investors deterred by what they saw as increased political uncertainty".

The pound has now retraced most of the gains it made this month after hitting lows in the aftermath of the Chancellor's decision not to raise interest rates.

It is approaching once again its previous lows of 2.1765 against the mark and 82.7 on the trade-weighted index on 9 May. Mr Mackinnon is forecasting that the pound will fall to 2DM by the end of the year.

As before this year, the pound has been caught in the slipstream of a weakening dollar. The rally in the dollar this month has proven short- lived. Since Wednesday it has fallen by four yen and by six pfennig against the mark.

The immediate reasons cited by dealers for the renewed bearish sentiment against the dollar are new signs that the US economy is slowing down more than expected. Two-year bond yields slipped below the Federal Funds rate this week, indicating that the market is now discounting a cut in US interest rates.

However, the scale and swiftness of the setback to the long-awaited rally suggests that long-term concerns about the dollar remain prominent in investors' minds. These include worries about the US slide into foreign indebtedness and the possibility that foreign holders of dollars are anxious to diversify out of the greenback.

The markets will now be looking closely at US figures in the coming week to see if the run of weak economic data continues. Particular attention will be paid to the consumer confidence index, the national purchasing managers index and the employment report at the end of the week.