views

POUND COULD HIT PARITY WITH DOLLAR

BORIS SCHLOSSBERG
DIRECTOR OF CURRENCY RESEARCH, GFT

LAST week I was on CNBC Europe when a viewer asked – will the euro go to parity against the dollar? I was surprised by the question, replying that despite the current turmoil in the Eurozone, such talk was a bit premature and reminded the audience that less than a year ago most foreign exchange strategists were forecasting the dollar’s rather than the euro’s demise.

But, now that I am back on my side of the pond and have had a chance to reflect a bit on the markets I believe that it is the pound rather than the euro that could have the strongest chance of reaching parity against the buck as the year progresses.

The currency market appears at the moment to be afraid of such a possibility – sterling collapsed more than 400 points at the start of this week, slicing through the psychologically important $1.5000 barrier on Monday.

The presumed reason for the pound’s recent spell of weakness was the prospect of a hung parliament. Election polls continue to show an uncomfortable tightening in the race between Labour, the Conservatives and the Liberal Democrats and traders are worried that the next UK government will be at a legislative impasse before it even starts.

However, the pound’s problems go well beyond mere politics. With one of the largest fiscal deficits in the G20, the weakest GDP growth among industrialised nations and an unhealthy over-reliance on its financial sector, the UK economy is highly vulnerable to a double-dip recession that could wreak further havoc with the country’s public finances and its currency.

Granted, the notion of the pound dropping to parity is an extreme scenario that may not come to pass. The currency’s all-time low against the dollar was $1.05 in 1985. However, given the fragility of the UK economy, the prospect of further downside drift in the pound remains quite high. The same speculative forces that drove Greek bonds to their lows could now begin to focus their fury on UK gilts.

And, if financing the UK public deficit becomes a concern in the capital markets and the Bank of England is forced to step in as the buyer of last resort, then the pound’s woes are not over.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read daily commentary on currencies at www.GFTUK.com/commentary or e-mail them at BorisandKathy@gftuk.com.