On April 10, the pound fell to a five-year low against the dollar

Tim Evershed

April 17, 2015: Uncertainty surrounding the result of next month’s UK general election is sending the sterling on a rollercoaster against the dollar.

On April 10, the pound fell to a five-year low against the dollar as election jitters combined with weak industrial data took it from $1.4623 from $1.4931 earlier in the month. The currency recovered some lost ground the following week ($1.4833).

The rebound confounded the conventional wisdom that expected the pound to fall in the run up to the election before rising after. But, it underlined the volatile nature of the market as the polls continue to show an election that is too close to call.

The Conservative and Labour parties are neck and neck in the polls making a hung parliament, in which no party wins overall control, likely and investors fear coalition negotiations will drag on much longer than after the last election in 2010.

A note from the bank Morgan Stanley said: “Under our base case scenario of the next UK government being led by one of the major parties, we would expect renewed fiscal austerity, which will lead to a slower growth picture in the UK.”

Investors are concerned that a Labour government might be unable to deal with Britain’s deficit and will slow economic growth, especially if it has to make a deal with the Scottish Nationalist Party.

On the other hand, a Conservative-led administration could lead the UK out of the EU, particularly if it has to work with UKIP, and that is a prospect that frightens many investors and businesses.

A hung parliament could even cause a “Lehman moment” for the UK, according to Kathleen Brooks, research director at Forex.com

Brooks added: “We’ve seen volatility pick up and that’s because of the election uncertainty. 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.”

The old adage is that markets hate uncertainty and that is certainly proving true with some predicting movements of up to 5 cents in either direction before and after May 7.

Currency traders are looking nervous at the moment with options, used to hedge exposures, in demand while risk reversals, a gauge of demand for options on a currency rising or falling, show a huge bias for sterling weakness against the dollar in the coming month.

Adding to this toxic mix for the pound is an inflation rate of 0% for February and March, according to the Consumer Price Index. This raises fears of deflation in the UK economy and would put pressure on the Bank of England to cut interest rates from its current 0.5%

The prospect of the UK maintaining, or even cutting, its historic low interest rates would be expected to keep the pound valuation down against the dollar.

Kit Juckes, an economist at Societe Generale, said: “I can’t see how the election can provide a positive outcome for the sterling. 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.”

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