The currency blog

After being sold aggressively across the markets yesterday the markets have taken a breather and we now await the next move. First let us dissect why the drop in sterling which fell over 2% against the USD pushing it to a 10 month low. Well the focus is political with the opinion polls over the weekend indicating that the chances of a hung parliament were much higher- so why does this cause a problem? A hung parliament may actually prove successful, however the markets do not like uncertainty and the consensus is that a coalition government will have less political clout to push through the decisive decisions especially in relation to tough fiscal planning which is inevitable.

The Conservatives have come out of the traps today stating that protecting the AAA status is central to their plans- however some feel their proposed aggressive cuts will be detrimental to recovery. On the other hand Labour propose to wait and cut later but waiting too long could mean that the horse has already bolted and the AAA rating could be lost. So this uncertainty and division is leading to a weaker pound. Yes this could be good for the UK economy and for recovery but there is a fine line between a weaker pound and the loss of confidence in Sterling and the UK economy- this would lead to a sharp rise in import prices and inflationary pressure especially if commodity prices remain high- not good; this would spill into a pressure on the UK gilt markets and inevitably the UK losing the AAA rating adding yet more pressure. So you can see the problem that uncertainty is creating. The pound needs to get back above the psychological 1.50 level against the USD. The Times summed up the weakness in the pound by empasizing its 7% since the beginning of February against the Zimbabwe Dollar!

Sterling also lost yesterday on the purchase by Prudential of AIG’s Asian business which led to further selling of GBP and buying of USD in the light of this purchase.

In other news the RBA raised interest rates by 25 basis points to 4%- giving further strength to the Aussie. The AUD still the darling of the currencies and expected to strengthen further against the major currencies going forward.

Discuss on this on the Currency Exchange Forum