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Mar 01
2010
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The short sellers made a killing on the euro. Now they're stalking the pound. by Eric Reguly
The fiscal woes of southern European nations such as Greece and Spain have preoccupied investors and political leaders for weeks. But the spotlight is now also on Britain, amid concerns its deficit is out of control and that no clear winner will emerge from the spring election.
A wild, two-hour trading session pushed the pound down almost 4 cents against the U.S. dollar Monday morning, taking it below $1.50 (U.S.), its lowest level since May. By the end of the session, the pound had declined 1.6 per cent against the dollar from its level at the end of last week, taking it to $1.49. It dropped 1.2 per cent against the euro. British government bonds, known as gilts, also got caught up in sterling's punishing ride.
While speculative currency traders have been focusing on the expanding British budget deficit, sterling's plunge yesterday appeared to be triggered by a YouGov poll, published in the Sunday Times, which showed that the opposition Conservatives may get too few votes to prevent Gordon Brown's ruling Labour Party from winning the most seats in the election. Until recently, the Conservatives, led by David Cameron, had a commanding lead in the polls.
Economists and currency traders warned that a hung parliament, where no party wins a majority, would lack the political authority to implement austerity measures. At slightly more than 12 per cent of gross domestic product (GDP), Britain's budget deficit is the same as Greece's.
“The last thing the financial markets want to see is a ruling party without the ability to implement tough measures to trim the deficit,” said one futures broker. “All of this is not lost on the speculative community.”
The latest data from the U.S. Commodity Futures Trading Commission (CFTC) reveals that net short positions against the pound – bets on the currency's decline – are approaching record highs. So far, the speculators have been right. The pound has dropped almost 8 per cent against the dollar and more than 2 per cent against euro since the start of the year.
It does not appear that the wagers against the pound will be unwound soon.
“The U.K. is trading on past economic glories at present and this will only continue for so long,” James Hughes, chief economist of Hong Kong's Black Swan Capital, said in a research note issued on Friday.
“Sooner or later the safe-haven status of sterling will wear off, as the full extent of the structural deficit becomes more apparent. When this happens, not only will sterling be sold off but there will be a sharp credit rating downgrade on gilts, which will force bond funds to sell and trigger a vicious downward spiral.”
The pound is ailing even though there are compelling signs that the British economy is on the mend. The weaker currency is boosting export orders and, according to the latest CIPS/Market purchasing managers' index, British manufacturing is growing at its fastest pace in 15 years.
The Office of National Statistics recently revised up its fourth-quarter GDP growth estimate from 0.1 per cent to 0.3 per cent, suggesting the recession is fading faster than had been expected.
Several forecasts have the pound hitting $1.30, give or take a few cents, by the end of 2010. They are emboldened by the government's plans to sell a record £225.1-billion ($337-billion U.S.) of gilts in the financial year ending this month, and by the announcement by Moody's Investors Service in December that Britain's credit rating “may test triple-A boundaries.”
The pound's plunge came as regulators ramped up their efforts to fix Greece's deficit problems before short sellers get a chance to wallop the euro again. On Monday, the European Union's monetary affairs commissioner, Olli Rehn, was in Athens to urge the government to do everything in its power to reduce the deficit. At 12.7 per cent, it is more than four times greater than the EU's 3-per-cent limit. “I want to encourage the Greek authorities to consider and announce additional measures in the coming days,” he told reporters.
As a precaution, the wealthiest countries in the 16-nation euro zone are working on contingency plans to prevent Greece from defaulting on its debt. A default would send bond yields soaring across the euro zone, raising the financing costs for all of the member countries. Countries with burgeoning debts and financing needs, like Italy, where the public debt rose last year to 116 per cent of GDP, are especially keen to prevent the Greek crisis from spreading.
One potential bailout plan would see some of Germany's private and state-owned banks, such as KfW Group, buy Greek bonds. Greece needs to raise more than €20-billion ($27-billion U.S.) to cover bonds that mature in April and May.