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HOW POUND IS BUFFETED BY POLITICS

BORIS SCHLOSSBERG<br /><strong>DIRECTOR OF CURRENCY RESEARCH, GFT</strong><br /><br />THE currency market often reacts with more force to political news than it does to economic data. Currencies represent nations as well as economies so traders would do well to remember the golden rule of FX trading: in head to head combat, politics almost always trumps economics. Political instability breeds uncertainty, threatening the safety of capital and the currency markets tend to sell first and ask questions later. <br /><br />Nowhere has this phenomenon been more evident recently than in the price action of the pound, which made a sharp reversal the moment rumours of a Gordon Brown resignation hit the screens last week. As the prime minister faced pressure from the Labour Party, the pound fell and broke the key 1.6000 support level.<br /><br />It may seem a bit absurd that in advanced industrialised economies where the rule of law is well established, markets react so viscerally to any change in the status quo. However, there are legitimate economic concerns that have arisen from the Labour Party&rsquo;s political turmoil. <br /><br />What worried FX traders was that Brown&rsquo;s departure would create a leadership vacuum when the UK budget faces double-digit fiscal deficits. Any lack of confidence in the government could result in a loss of faith by the bond market &ndash; making it difficult and expensive for UK policy makers to finance government spending, which could prove disastrous to the UK&rsquo;s nascent economic recovery.<br /><br />With a Labour government looking sure to limp on until next Spring, much of the uncertainty that will flow from a weakened government has already been priced into the pound. A change in Labour leader might have proved positive for the pound, but we will have to wait for the next government which, we can assume, will be more palatable to the markets. <br /><br />Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read daily commentary at www.GFTUK.com/commentary or e-mail them at BorisandKathy@gftuk.com.