One of the biggest surprises in the first part of this year had been the outperformance of sterling against a basket of currencies with the best performance coming against the higher yielding Scandinavian currencies.
A lot of this outperformance had been as a direct result of speculation that the Bank of England was on the way to raising interest rates as early as next year, and before the Federal Reserve, on the basis of an improving economy, and continued falls in the rate of unemployment.
This saw the pound rise to its highest levels since mid-2009, in the middle of the summer, prompting concerns from business that the higher value of the pound was starting to impact on competitiveness.
In any event these concerns have diminished significantly in recent weeks, as concerns about a slowdown in growth across the world, and the Scottish referendum caused investors to take profits on their recent sterling gains.
This, and a sharp fall in inflationary pressures, has prompted a significant paring back of expectations about a potential rise in interest rates,
despite some dissent on the Bank of England MPC about when to expect some tightening of policy.
As a result the pound has weakened in recent weeks after peaking at 1.7145 in July this year against the US dollar.
This recent weakness in the pound could gain traction in the next few months
irrespective of perceptions about the future direction of UK interest rate policy for any number of reasons, but the two main drivers
are likely to be the future path of US monetary policy
, which at the moment could well see a tightening in the early part of next year, and the possibility of a change in the UK government
at next years General Election.
While UK GDP appears to be holding up fairly well
, despite concerns about what is happening in Europe, the direction of the opinion polls ahead of next year’s election is likely to be a key determinant in how business views the direction of UK fiscal policy over the next few years.
With next year’s election outcome looking more and more uncertain, the emergence of UKIP and the SNP is likely to cause some businesses to defer important business decisions until after next year’s vote, which could well hit economic growth in the first half of next year.
A number of UK businesses have already expressed concern about some of the Labour oppositions more interventionist policy pronouncements on the energy sector, the banking sector, the housing sector and now the water sector.
We saw in 2010 how political uncertainty helped undermine the pound in the lead up to that election where the pound similarly peaked just above 1.7000 in July 2009, before sliding sharply into the autumn period, and then rebounding into the year end, before sliding sharply as the election approached.
Concerns about political uncertainty are likely to be a similar story in 2015 given the current fragmentation in UK politics,
and the rise of UKIP in England and Wales, and the SNP in Scotland, either of whom could well hold the balance of power
in a new UK administration, and whose demands could well be not particularly business friendly.
As we head into 2015 we could see a similar story unfold with respect to a decline in the pound.
In the lead-up to the 2010 general election we saw a sharp decline in the value of the pound as uncertainty grew about the prospects of a new government amidst a backdrop of concerns about the UK’s public finances, the prospects for the UK economy, and interest rate policy, which now appears to be lagging behind US interest rate policy where a rate rise there is becoming that much more likely.
Next year’s election is unlikely to that much different, and in fact it could be much worse with dysfunctional politics likely to be a bigger risk to financial stability
with the likelihood that we could get another hung parliament, only this time with the SNP or UKIP holding the balance of power.
While there are differences now
, UK gilt yields in 2010 were well above 3.5%, and there was deep worry that unless action was taken to address the UK’s fiscal problems that we could see a run on the pound. The head of the world’s biggest bond fund PIMCO even went as far to say that the UK economy and its debt were sitting on a bed of nitro-glycerine, and while the current situation doesn’t seem anywhere near as serious now, the underlying concerns about the UK economy have not gone away.
While the so-called nitro-glycerine scenario appears to have passed, any prospect of a new government being anything less than serious about dealing with the UK’s many problems could well lead to increased uncertainty ahead of next May’s key vote
, especially given the toxicity of the two main parties, amongst some voters and the populism permeating into the UK political landscape.
This week’s Autumn Statement and next year’s March budget are quite likely to be extremely political in nature, and are likely to offer little in economically tangible or positive terms,
with respect to the UK economy, and the nature of the recent recovery.
With the polls likely to remain tight right up to polling day, and the two main parties haemorrhaging votes to UKIP and the SNP the ensuing political uncertainty, as well as weak inflation, is likely to keep interest rates firmly on hold until well after next year’s vote, and could well weigh on the UK economy as businesses hold off key investment decisions ahead of the outcome.
Given this uncertainty and the way the Labour opposition is positioning itself in the context of its attitude towards business in general, it is hard to feel optimistic in any way about strong sterling gains over the next few months,
and while we might see a small sterling rally into the year end, as we did in 2009, it is hard to see much prospect of one as we head towards next year’s general election, as politics outweighs economics as the main headwind for the UK economy in 2015.
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