Pound No Longer Sound As Investors Fear Double Dip
Monday, March 01, 2010

Talk of a 'double dip' recession and mounting worry within the international markets that the British government may not be able to service its growing debt is weighing heavily on the pound, which sank to its lowest against the dollar for nine months on Thursday.

In the wake of weak economic data for January, and the prospect that the government would have to revise down economic growth figures for the fourth quarter of 2009 (the 0.1% GDP growth which the government was keen to point out had put an official "end" to the recession), investors have begun to dump sterling in favour of safer bets such as the US dollar and the Japanese yen. Following the revelation that UK capital expenditure fell by almost 25% in the last quarter of 2009 compared to the final quarter of 2008, the pound sank to just above the USD1.52 mark, and even fell in value against the euro, which is itself being undermined by the fiscal crisis in Greece and the fiscal storm clouds looming above other eurozone members, particularly Spain and Portugal.

While some analysts suggest that fears about the UK economy and the government's ability to control its rising budget deficit and public debt are overblown, the future outlook for the pound is clearly negative. Indeed, one influential analyst, George Magnus, senior economic adviser to UBS, has suggested that sterling could plunge to as low as USD1.05 and pass parity with the euro if the fiscal reins are tightened to the extent that any fragile economic recovery is choked off.

This is Magnus's prognosis should the Conservative Party, which is talking aggressively about cutting public spending, wins the forthcoming general election, which must come before June this year. "If premature fiscal tightening after this year's election drives the UK economy back into recession, the reaction in currency markets is likely to be savage," he warned in a research note to clients.

Magnus believes that such a policy would not only endanger tax revenues, but also have ramifications for Britain's sovereign rating and the recovery of the banking sector. "The severe fall in sterling after such a policy mistake would reflect a crisis of confidence in Britain's policy making," he added.

Worryingly for the UK government, Jim Rogers, co-founder of the Quantum hedge fund with George Soros, suggests that the pound is already in trouble, and will likely continue to slide no matter who wins the election.

"Other currencies aren't strong and the euro has real problems, with cracks much wider than Greece beginning to show. But it's the pound that's most vulnerable," said Rogers, whose fortune suggests he gets things right more than he gets them wrong. "In real terms, [sterling has] already devalued against virtually every currency barring the Zimbabwean dollar and it's especially exposed over the weeks running up to the UK election. In a basket of currencies, the pound is potentially a basket case."