BS: Pound Falls on Debt Concern as Coalition Talks Enter Fifth Day
By Paul Dobson
May 11 (Bloomberg) -- The pound fell against the dollar as negotiations to form the next U.K. government entered a fifth day, stoking concern the nation’s political leaders will delay taking steps to cut the record budget deficit.
Sterling dropped for the seventh time in the past eight days as Prime Minister Gordon Brown’s Labour Party and the Conservatives jockeyed for the support of the Liberal Democrats after last week’s election produced no outright winner. Brown said yesterday he would quit to advance talks with Britain’s third-biggest party. The Treasury sold 2.25 billion pounds ($3.3 billion) of 2027 bonds today.
“The longer this goes on, the weaker sterling will trade,” said Paul Robson, a senior foreign-exchange strategist at Royal Bank of Scotland Group Plc in London. “Financial markets want to see credible fiscal plans.”
The U.K. currency fell 0.5 percent to $1.4767 as of 12:47 p.m. in London, after sliding to as low as $1.4721, and declined 1.5 percent to 136.49 yen. Sterling appreciated 0.3 percent to 85.86 pence per euro.
Conservative leader David Cameron said it was “decision time” for his Liberal Democrat counterpart, Nick Clegg, after yesterday sweetening his position with a proposal for a referendum on changes to the U.K. electoral system. Clegg said he’d make an announcement “as quickly as we possibly can.”
Offer Sweetened
The negotiations over a coalition were triggered by the first election since 1974 that failed to produce a majority. Sterling has fallen 4.5 percent this year, according to Bloomberg Correlation-Weighted Currency Indexes, as the prospect of a hung parliament added to concern the government would be too weak to manage the U.K.’s 167 billion-pound budget deficit. At more than 11 percent of gross domestic product, it’s the biggest shortfall among the Group of Seven nations.
The 10-year gilt yield was little changed at 3.93 percent, after reaching 4.02 percent, the highest since April 26, according to Bloomberg generic data. The two-year note yield slipped almost 2 basis points to 1.12 percent, snapping three days of gains.
“The uncertainty has really picked up in the U.K. and that’s why you’re seeing a loss of confidence in gilts,” said Orlando Green, an interest-rate strategist at Credit Agricole Corporate and Investment Bank in London. “The market would prefer the Conservatives and Liberal Democrats. The Conservatives’ fiscal credibility seems to be higher because of their deficit-cutting commitments.”
Deficit Reduction
Labour has pledged to cut the U.K.’s budget shortfall in half by 2014, while the Conservatives said they’d go further and faster if they take office. Brown has said the Conservative plans to begin spending cuts this year risk plunging the economy back into a recession.
Not all economic data points to the recovery strengthening. A British Retail Consortium survey today showed stores had their largest drop in sales in more than a year last month.
U.K. factory production climbed more than five times as much as analysts forecast in March in the biggest jump since 2002, data from the Office for National Statistics showed. Manufacturing output rose 2.3 percent from February, the statistics bureau said. The median forecast of 24 economists surveyed by Bloomberg was a 0.4 percent increase.
A house-price gauge rose for the first time in five months in April. The Bank of England is scheduled to present its quarterly inflation report tomorrow.
‘Good Thing’
Today’s gilt sale drew an average yield of 4.472 percent, with investors bidding for 2.47 times the securities offered. That’s more than at an auction of the bond in August, when the bid-to-cover ratio was 1.88 times.
“Having the auction at a time when there’s so much political uncertainty and getting it away is enough” to support gilts, said Elisabeth Afseth, an analyst at Evolution Securities Ltd. in London. “Given the environment we’re in, stronger economic figures are a good thing because it helps on the deficit side.”
Gilts underperformed this year, returning 2 percent, according to Bank of America Merrill Lynch indexes. That compares with 2.9 percent for U.S. Treasuries and 4.3 percent for German bonds, the indexes show. The extra yield investors demand to hold U.K. 10-year gilts rather than German bunds, the euro-region’s benchmark debt security, widened 5 basis points today to 102 basis points.
‘Least-Liked Option’
“A Labour-Liberal government is the least-liked option by markets and would almost guarantee a downgrade of the U.K. sovereign,” a team of analysts at BNP Paribas SA led by Hans- Guenter Redeker in London wrote in a research note today.
The rating action is likely “since both parties agree that early expenditure cuts could harm the economy,” the analysts said in the note. As a result, investors should sell the pound against the dollar, they said.
Morgan Stanley also said investors should sell the pound, forecasting $1.35, citing the prospect of a coalition between the Labour Party and the Liberal Democrats.
The cost of insuring against losses on U.K. sovereign debt jumped, with credit-default swaps rising 6.5 basis points to 88 basis points, according to CMA DataVision prices. The increase signals investors’ perception of the nation’s credit quality has deteriorated.
None of the potential outcomes “bodes particularly well for the prospects of fiscal consolidation,” Michael Hart, a currency analyst at Citigroup Inc. in London, wrote in an investor note today. “Markets may be too complacent about the risks of a fiscal crisis in the U.K. Prospects of higher interest rates in the face of accelerating inflation may not suffice to stand in the way of a weaker pound.”
Political Deadline
Britain’s political leaders must ease the post-election deadlock by the end of the week to avoid unsettling investors, said Richard Lambert, head of the U.K.’s biggest business lobby.
“People would be feeling pretty uncomfortable if by the weekend the position wasn’t clearer than it is now,” Lambert, director general of the Confederation of British Industry, said in an interview with Bloomberg Television in London yesterday.
“Although damage to the pound has so far been limited, one has to assume markets will at some point lose patience if a government is not formed,” Adam Cole, head of global currency strategy at Royal Bank of Canada in London, said today in an investor note.
--Editors: Daniel Tilles, Keith Campbell
To contact the reporter on this story: Paul Dobson in London at pdobson2@bloomberg.net
To contact the editor responsible for this story: Justin Carrigan at jcarrigan@bloomberg.net
