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Sterling won't get hung up on hung parliament

Source: Reuters - Tue 20th Apr 2010

Sterling is poised to rally in the wake of next month's election as the market has become more comfortable with the idea no clear winner will emerge.

The latest opinion polls showing a big gain in recent days by the Liberal Democrats renewed expectations of a hung parliament, in which no party has an overall majority after the May 6 vote.

Sterling gapped lower to a 1-1/2 week low of $1.5192 on Monday but was still up almost 3 percent from mid-March, when initial concerns about an inconclusive election result knocked it down to the year's low of $1.4798.

While analysts say tackling the deficit is crucial to sterling's long-term health, markets are more sanguine than they were a month ago about the immediate impact on the pound of an indecisive result.

"Sterling is vulnerable to wobbles on news ahead of the election, but barring a catastrophe, sterling would represent a good buy after the vote" said Daragh Maher, deputy head of FX strategy at Credit Agricole CIB.

"The premise that a hung parliament would create a policy vacuum is wide of the mark, as all parties know they need to bite the bullet and deal with the budget deficit."

"It would be wrong and simplistic to get hung up on a hung parliament."

Negative sentiment surrounding the hung parliament scenario may have been overdone and has already been partially unwound. 

Investors had worried that a hung parliament would reduce the new government's ability to tackle Britain's hefty debt, set to rise to almost 12 percent of GDP this year, and possibly trigger the loss of its top-notch sovereign rating.

This, along with expectations monetary policy would stay loose after the parliamentary vote, were until recently seen depressing sterling.

Investors have already begun cutting back on their bets against sterling. Latest data from the U.S. Commodity Futures Trading Commission showed speculators reduced net short sterling positions to 57,391 for the week ended April 13, off a high of 71,624 in late March.


The pound may also see a degree of support from an improving economy, as British exports and factory activity have picked up thanks in part to a weaker pound. Exports of goods and services comprise nearly 30 percent of UK gross domestic product.

Stronger data helped lift the pound off its mid-March lows to an April 15 high of $1.5524 until the Lib Dem surge took its toll.

"The cyclical backdrop will be sufficiently favourable for the market to look beyond the initial uncertainty of the election," said Credit Agricole's Maher, who targets the euro at 83 pence by year-end, compared with around 88 pence on Monday.

An inflationary threat from a falling pound - a point highlighted by the Bank of England last month - could also alarm policymakers and lead to sterling-supportive rhetoric.

"If it persisted, the recent further depreciation of sterling was likely to put additional upwards pressure on inflation over the next few quarters" minutes from the BoE's March 3-4 meeting said. Inflation remains more than one percentage point above the BoE's target. 


With markets overcoming fears about a hung parliament, sterling may face a win-win situation. If the election does produce a clear victory, it is likely to see a relief rally.

"The key thing would be having a definite winner as this would remove the cloud of uncertainty" said Ned Rumpeltin, Nomura's senior London currency strategist.

Simon Derrick, head of FX research at Bank of New York Mellon, said neither a minority nor coalition government was likely to produce sterling weakness, although a protracted process in forming a new government could hurt the pound.

"A clear and workable coalition would need to be put together ahead of the end of Sunday (May 9)" he said. "If nothing happens at the weekend, the market will not give the new government the benefit of the doubt and you would have a knee-jerk negative reaction in the pound."

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