Election chaos could trigger ‘Lehman moment’ for pound

The pound faces a month of uncertainty that could see sterling plunge to levels not seen since the depths of the financial crisis, analysts have warned.

Official data this week could show the UK entered deflation in March for the first time in at least a quarter of a century, reports The Telegraph. This would weaken the pound from its current level of $1.4630 against the dollar and send sterling closer to its 2010 post-election low of $1.4230.

Kathleen Brooks, research director at Forex.com, said the pound would “drop like a stone” if Office for National Statistics (ONS) data showed a big drop into deflation, against current expectations that price growth, as measured by the consumer prices index, remained at a record low of zero last month.
Ms Brooks said election uncertainty was an even bigger driver of sterling’s weakness. She warned that Britain could experience another “Lehman moment” in the event of a hung parliament, with the pound moving closer to the low of $1.35 seen in 2009 after the US investment bank collapsed.

“We’ve seen volatility pick up and that’s because of the election uncertainty,” she said. “We don’t know whether or not we’ll be under a Labour government that could be bad for the deficit, or under a Tory government that could take us out of Europe. Will we even have a government at all? There’s still a big chance of a hung parliament.”

Kit Juckes, an economist at Societe Generale, said traders were braced for a “messy outcome” after the May 7 poll that would drive sterling to $1.40 against the dollar if the euro also continued to weaken against the greenback.

“I can’t see how the election can provide a positive outcome for sterling,” said Mr Juckes. “It’s just a source of uncertainty for international investors. Apart from the fact that it would be an enormous shock if you got an outcome where any single party could form a government, the politics just produces negative sentiment, volatility and a nervousness that has bred the sense that nobody wants to buy [the pound].”

George Osborne said on Sunday that a Labour-led government would leave the country “exposed to the economic storms in the world” and “trash this economy” as the Chancellor defended the Tory pledge to pump £8bn more into the NHS by 2020.

“Let’s be clear, if we have an Ed Miliband-Scottish National government, they will trash this economy and they won’t be able to pay for public services and they will undermine economic security,” he said on the BBC’s Andrew Marr show. “This would cost people jobs in this country and we will be back to square one and that would be an outrage.”

Some economists believe inflation fell to -0.1 per cent in March, which would represent the lowest rate since records began in 1989. It would also mark the first period of deflation since March 1960, according to unofficial ONS data dating back to 1950.

“If you got a big shock, say -0.3 per cent, I think that would be when the panic stations would ring and then we’ll get into a real parabolic phase when you just see the pound drop like a stone,” said Ms Brooks.
Markets do not expect policymakers to raise rates from a record low of 0.5 per cent until the second half of 2016. However, most economists expect inflation to pick up in the second half of the year once the impact from the dramatic drop in the oil price fades.

Sterling fell to a five year low of $1.4587 against the dollar last week as disappointing manufacturing and construction data suggested Britain’s recovery slowed in the first three months of this year.

However, in a week where official data are expected to show unemployment fell to a six-and-a-half-year low of 5.6 per cent in the quarter to February, economists expect pay to continue to rise in the three months to February, with regular pay rising to 1.7 per cent compared to a year ago, from growth of 1.6 per cent in the three months to January.

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