Confidence in sterling is on the up after the budget

If the advent of a coalition government has brought a sea of change for British politics it has also brought one for the pound. After initial scepticism that a hung parliament would spell anything other than gloom for the country, investors – and apparently, to a large extent, the population – have quickly come to the conclusion that It Might Just Work, Captain.

During the first month after the election the government spread the word that its ’emergency’ budget would be a harsh one. Between them, politicians and the media painted a ghastly picture of frozen public sector salaries, tax increases, job cuts and pension rearrangements. And that was just the good bit. The population was optimistic that the cuts would hit other folk harder than themselves. Investors hoped the new government would have the guts to address the problems and solve Britain’s systemic borrow-and-spend culture. The budget was billed as a corker and so it turned out to be.

Chancellor George Osborne’s plan was to reduce the annual budget to almost zero within the life of the parliament, five years. He would do it with a mix of spending cuts and tax rises that would, he hoped, spread the pain ‘fairly’. In a previous era his brave promises would have been undermined by dodgy statistics: British chancellors in the past have been notorious for swerving their projections of economic growth to suit their argument. This time, the job of making those forecasts has been outsourced to a non-political triumvirate of respected economists; the Office for Budget Responsibility. When Mr Osborne built into his plan the prospect of 1%-3% economic growth over the next five years financial markets were prepared for the first time to believe it because the projections were not politically-inspired.

Understandably, Britain’s workers and pensioners were worried by how much these austerity measures would cost them, personally, in the years to come. It is of little consolation to know that others are being equally hurt. Yet there seems to be an acceptance that something had to be done and that five years’ pain is preferable to endless years of lingering misery. There was no such dichotomy of sentiment for the world’s investors. They saw the sharp sword of fiscal probity slice, with a single stroke, through the Gordian Knot of Gordonian profligacy and they were impressed. The chancellor had said early in his speech that an important aim was to preserve Britain’s priceless AAA credit rating; by the end of it he had done just that.

It would be an exaggeration to say that sterling went from pariah to paragon in the space of an hour-long budget speech but it would not be much of an exaggeration.

On the other side of the equation the euro has, over the space of little more than six months, slipped from being the world’s second or third most trusted reserve currency to a position of distrust. The trillion-dollar safety net for failing euro zone nations, which was put in place in early May has done its job so far: Greece has not gone bust. But it has failed to generate the confidence that its authors hoped for. Were Greece to have to borrow money on the open market today it would still have to pay eight percentage points more in interest than Germany pays. That’s an awful lot. There is also nervousness about EU plans to ‘stress test’ Euroland commercial banks. The idea is to model possible future financial crises and to see how the banks would fare if, say, Greece were to default on its borrowings. The results are likely to be horrible for some institutions because they have so much of their money invested in government bonds and in failing real estate developments in southern Europe. The euro is looking shaky for all the right reasons.

The situation facing the sterling/euro exchange rate is almost a mirror image of the picture at the end of last year. Investors have regained, to a large extent, their confidence in the pound and have lost much of their faith in the euro. It is far easier today to be upbeat about sterling and downbeat about the euro than it has been for a long time. Although there can be no guarantee that sterling/euro will be higher in six months’ or a year’s time than it is today, there are many reasons why it is likely to be. Any sterling-based investor needing to buy euros in the foreseeable future should consider hedging much less of their exposure than the 50% that prudence normally requires.

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This entry was posted on Tuesday, June 29th, 2010 at 3:00 pm and is filed under Currency exchange, Finance, Money transfer, Real estate market . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

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