Cameron’s Weakening Pound Shows UK Austerity Doubts

Wednesday, 20 Mar 2013 07:33 AM

 

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The pound is bearing the brunt of a loss of confidence in the economic policies of U.K. Prime Minister David Cameron.

Sterling has weakened more than 7 percent against the dollar this year. In the week through Sept. 16, 1992, when investor George Soros earned $1 billion by helping to force the pound out of the exchange-rate system that preceded the euro, sterling dropped by 9.5 percent. Black Wednesday, as the day became known, damaged the Conservatives’ reputation for economic competence. Economists and investors say a similar judgment faces the present Tory-led government unless it gets the economy moving. U.K. bonds are the world’s worst performers this year.

Chancellor of the Exchequer George Osborne delivers his annual budget to Parliament amid calls by the opposition Labour Party and even his own Cabinet colleagues to spur an economy at risk of falling into a third recession in five years. Britain has recovered only half of the output lost in 2008-2009, and the country forfeited its top credit rating at Moody’s Investors Service on Feb. 22. Output in the U.S. is back above its pre-recession peak and the recovery is gaining pace.

“The chancellor’s policy is bankrupt -- he is going to have to face that,” Robert Skidelsky, a member of the upper chamber of Parliament without party affiliation and biographer of John Maynard Keynes, said in a phone interview on March 14. “The economy is not growing, the pound will go on slipping and we will lose further credit ratings.”

No Growth

When Cameron and Osborne took office in May 2010, they predicted the economy would grow more than 5 percent over the next two years, a budget deficit equal to 11 percent of gross domestic product would fall to 2 percent by April 2015 and the U.K. would keep its top credit rating. Instead, output rose 1.1 percent, the deficit is still 8 percent of GDP and analysts say Fitch Ratings and Standard & Poor’s will follow Moody’s in downgrading Britain’s credit score after Wednesday’s budget.

Credit-default swaps insuring gilts rose 67 percent from a more than four-year low of 26 basis points on Nov. 1, the most among 67 governments tracked by Bloomberg. The premium investors demand to hold gilts rather than German bunds has increased almost fivefold since August to 48 basis points.

BOE Stimulus

Constrained by his self-imposed austerity program, Cameron is relying on the Bank of England to revive the economy. The central bank has bought 375 billion pounds ($566 billion) of government bonds since March 2009 as part of its quantitative- easing program and kept its benchmark interest rate at a record low of 0.5 percent.

Investors are speculating Osborne will give BOE policy makers more room to pursue growth as Mark Carney prepares to take over as governor on July 1, even if it means inflation staying above the 2 percent target. Consumer prices rose 2.8 percent in February from a year earlier, the fastest pace since May, the Office for National Statistics said.

“The fiscal side of things certainly plays in and is impacting via the monetary policy route because that has to do more of the work,” Ian Stannard, head of European currency strategy at Morgan Stanley in London, said by phone on March 18. “That is putting the pound under pressure.”

Pound Losses

Sterling has lost 4.8 percent since the end of 2012, the worst performer after the yen, according to Bloomberg Correlation-Weighted Indexes. The pound has had its worst opening two months of the year since 1985 against the dollar. It tumbled to a 2 1/2-year low of $1.4832 on March 12 and was trading at $1.5094 as of 5:30 p.m. in London Tuesday.

Gilts fell 0.5 percent in pounds and 7.5 percent in dollars this year, the most among 26 indexes tracked by Bloomberg and the European Federation of Financial Analysts Societies. The yield on the benchmark 10-year gilt will rise to 2.46 percent by year-end compared with 1.86 percent, according to the weighted average in a Bloomberg News survey.

Black Wednesday broke Britain’s peg to the deutschmark as the Treasury failed to defend the pound against short sellers such as Soros who bet sterling was overvalued in the European Exchange Rate Mechanism, a euro precursor that required members to keep currencies within trading bands.

Sterling dropped 12 percent against the German currency between Sept. 15, 1992 and the end of that year, and by 19 percent against the dollar. While the decline aided Britain’s recovery from recession by making exports more competitive, the ERM crisis shattered public confidence in John Major’s government. In the 1997 election, the Conservatives lost to Tony Blair’s Labour Party, which retained power until 2010.

Cameron’s Challenge

The pressure on the pound this year underlines the challenges facing Cameron, 46, who witnessed the events of Black Wednesday as a 25 year-old adviser to then Chancellor of the Exchequer Norman Lamont.

Britain’s economy was 3 percent smaller in the fourth quarter of 2012 than it was in the first quarter of 2008. Only Italy has had a worst performance among leading industrial nations. By contrast, output in the U.S. was 2.5 percent above its previous peak in the fourth quarter of 2007. The American economy will grow 1.9 percent this year, while Britain’s will expand 0.9 percent, median forecasts in a Bloomberg survey show.

Osborne should be replaced as finance minister, according to 44 percent of people questioned by U.K. polling company ComRes Ltd. between March 15 and March 17. Sixty-one percent said Britain was heading for another recession and trust in Osborne to run the economy stood at minus 40, a drop of 13 percentage points from a year earlier. The poll of 2,032 adults was broadcast by ITV News.

‘Poor Position’

Morgan Stanley cut its year-end forecast for sterling by 8.9 percent on March 18. The bank estimates the pound will trade at a 33-month low of $1.43, from a previous forecast of $1.57. The median estimate compiled by Bloomberg is for sterling to end the year at $1.52, compared with a forecast of $1.60 at the end of December.

“The poor position of the fiscal backdrop, the failure of the government to be hitting all of its fiscal targets and the fact that growth prospects have disappointed are all part of the reason why sterling is weaker,” Jane Foley, a senior foreign-exchange strategist at Rabobank International in London, said in a phone interview on March 15. Rabobank cut its second quarter forecast by 4.5 percent to $1.49 to $1.56 on March 8.

Rebuffing opposition arguments that austerity is depressing the economy, Osborne has ruled out any relaxation in the budget, saying it would drive up government borrowing costs. Cameron’s spokesman, Jean-Christophe Gray, told reporters that departments face further budget cuts over the next three years to fund an extra 2.5 billion pounds of capital investment.

No Ideas

Britain is facing a difficult economic situation and the government is doing everything it can to help people who work hard, said a Treasury spokesman who declined to be named in line with government policy, when contacted by Bloomberg News.

“The coalition don’t seem to have any ideas up their sleeve about how to create any kind of growth, so my fear is that things get a lot worse in the short term,” Haig Bathgate, chief investment officer at Turcan Connell in Edinburgh, which manages about 1 billion pounds ($1.5 billion), said by phone on March 13. “We are going to keep diversifying out of sterling for the foreseeable future.”

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