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UK General Election - Sterlings Fate

UK General Election - Sterlings Fate

Old Feb 9th 2010, 9:27 pm
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Post UK General Election - Sterlings Fate

Morning all,

A number of Britishexpats members have sent me questions relating to the upcoming UK General Election and the likley impact they will have on Sterling. As I've received 11 such messages I thought I'd pen my response publically.

In 2010 the debate will focus on the impact of actions taken by Central Banks and Governments, coupled with the sustainability of economic recovery. For Sterling’s sake, a General Election will determine who holds the reins to the UK’s recovery, but reducing debt needs to be high on the campaign agenda to keep the UK’s credit-rating strong. Global risk appetite will again be a critical factor influencing exchange rates and the potential for raising interest rates could also become a decisive factor.

A currency’s value will also be determined by the health of its economy; a thriving economy will typically attract more investment and capital inflows and export more goods. To invest, or to purchase a country’s goods and services, investors and consumers will need to purchase that country’s currency, causing the currency to appreciate. With many countries having exited recession in the third quarter of 2009, the focus is now on the comparative rate and sustainability of that recovery.

As Britishexpats forum users will be only too aware, Sterling has been incredibly weak against all its major counterparts amid concerns about the state of the UK economy. Increasing levels of debt coupled with a high dependency on the fragile financial services sector has undermined confidence in the Pound.

So how would a Tory government affect Sterling’s prospects this year? As ever, there will be a huge amount of factors that will determine the movement of Sterling this year such as how much the economy recovers, whether interest rates can be increased and if quantitative easing is reversed. But Sterling will largely be driven by market confidence about the debt being repaid there are concerns over our sovereign debt rating being cut making it more difficult and expensive for the UK government to borrow.

Were the Conservatives to win the next election, as many political pundits predict, the test for the Tories will be whether or not they will put the country’s finances before the country’s public services. Will they risk the unpopular but necessary cuts in public spending and services to be able to show the markets they are serious about reduce the debt, without derailing an expected sluggish recovery? They certainly talk a good game and seem to take the risk of a ratings downgrade on our sovereign debt more seriously than the current residents of 10 and 11 Downing Street.

Even if the ratings agencies weren’t to cut our rating, markets are free to choose whether or not to buy our debt. If they choose not to, we will have to offer higher interest rates to sell it, increasing the funding costs of our debt more making it harder to pay down the debt.

To sum up, Sterling’s fate will largely be in the hands of whoever wins the election. The Tories are likely viewed the better candidate to deal with the debt, but only time will tell if they are willing to put our money where their mouth is!

Hope this is useful.

Mark
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