Politics Driving Sterling Latest Report

Online, February 26, 2010 (Newswire.com) - Sterling managed in January to recovery at least a little of its pride. After a deja-vu rally the day before new year's eve it sank back to wallow around the same levels it had occupied during the previous couple of months but once the new year break was out of the way it showed renewed signs of life.

Initially the main driver was British politics. The (non-existent) constitution has it that there must be a general election by the end of the first week in June. It is up to the prime minister to decide the exact timing but Westminster pundits reckon the most likely date is Thursday 6 May. Thus far, the opinion polls have had the Conservative party in the lead and investors are comfortable with that projection, as are the credit ratings agencies. It is not that they prefer Mr Cameron to Mr Brown at a party-political or personal level, nor that they are inherently more right-wing than socialist in their leanings. They want to see a concerted effort to reduce the gap between tax revenues and government spending. They believe the ruling party does not have the will to address that problem and that regime change is necessary.

So it was that the back-bench coup to unseat Mr Brown was greeted with dismay by investors. It looked, briefly, as though the prime minister might be replaced by someone who could actually win the election for Labour. The pound fell. When it became clear that the putsch had come to nothing, and that it would indeed be Mr Brown leading his party to defeat in May, the pound discovered renewed support. UK party politics is not usually a big deal for the value of sterling but for the next four months that is likely to be the case.

But sterling's biggest driver in January was not domestic politics but European politics, especially the goings-on in Athens. Greece is not a traditional bulwark of stability - or otherwise - for the euro but it is in the spotlight at the moment because of its own budget deficit, against which Britain's problems look trivial. The UK is heading for a situation where the national debt will be equivalent to 80% or more of annual economic output. For Greece the figure is 120%, going on 140%. It is unsustainable. Because Greece is a member of the euro it does not have the opportunity to devalue its way out of trouble. It can either leave the single currency and bring on a new Drachma (unlikely) or raise taxes and cut public sector wages and spending (painful). So far, the government has not made the 'difficult decisions' that the European Central Bank believes to be necessary and investors are worried.

Greece is not a key player in the euro zone economy in the way that France and Germany are. But its, its involvement in the Euro currency makes investors nervous about what might happen if Greece cannot get its fiscal act together. That nervousness has allowed sterling to sneak into the lead, despite its own domestic issues.

The pound is not on the rails in the way it was in autumn last year. There has been no recent talk of parity with the euro and beyond. Its performance in mid January reassured those who had written Sterling off and it was not unreasonable to think it might regain the 'highs' of last summer and even have a stab at €1.20 until the recession 'ended' with growth of almost nothing in the fourth quarter. If you need to convert pounds into Euros, buying Euros now at a cent or more above last year's average price would not look like a total cop-out.

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