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British Pound to Follow Risk Trends as EU Strife Continues

British Pound to Follow Risk Trends as EU Strife Continues

2010-05-15 02:58:00
Ilya Spivak, Sr. Currency Strategist
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The acute uncertainty about the UK political landscape has receded (for now), with the Conservatives bringing the Liberal Democrats into a coalition that looks fairly coherent and – at least rhetorically – committed to dealing with the nation’s gaping budget deficit. On balance, the markets have a reason to feel relieved: Tory ministers hold control of welfare, the big public services and foreign affairs, meaning the Lib Dems will not have much room to derail deficit reduction or indulge in their desire to bring the UK closer to continental Europe. All that remains now is execution. This has already begun with a pledge to reduce public spending by 6 billion pounds this year, but traders won’t be able to make a real educated guess on the new government’s resolve until it announces an emergency budget, which is expected in June.

The monetary policy landscape is equally static for the time being. BOE Governor Mervyn King and company stressed the need to rein in public finances in their quarterly inflation report but they will not be able to gauge the specifics of the fiscal landscape for some time. This likely means that policy remains on hold for now, and in any case, the central bank would surely not consider tightening given the kind of austerity measures that it expects politicians to deliver. Indeed, with the government is cutting back, it is all the more important to retain an accommodative monetary environment to assure the economy does not slide back into recession.

All in all, this leaves risk sentiment as the only somewhat straight-forward fundamental catalyst for the British Pound. The currency remains closely correlated to the MSCI World Stock index and despite being outside of the Euro Zone is still on the hook for a portion of the 500 billion euro EU stabilization fund, suggesting sterling will continue to follow the ups and downs of equity exchanges as the sovereign credit fiasco on the continent continues to play out.

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