Sterling will not suffer further in hung parliament

CLEGGMANIA appears to have grabbed Britain – or at least its front pages – in the wake of last week’s first televised debate. Polls yesterday put Nick Clegg’s Liberal Democrats just two points behind the Conservatives and four points ahead of Labour. The prospect of a hung parliament is becoming a real possibility, even if support for the Lib Dems does wane over the course of the next two weeks.

As support for the Liberal Democrats has grown, sterling has weakened. Since last Thursday, the pound has fallen as much as 2 per cent against the dollar and 0.8 per cent against the euro, although yesterday’s higher-than-expected inflation data gave sterling a bit of a boost. A stronger showing for the Lib Dems will certainly reduce the majority of the leading party and could result in a hung parliament. The markets are concerned that such a scenario would make fixing the public finances a more difficult task. Consequently they have been selling sterling.

With two more debates scheduled ahead of the election and the polls tightening, foreign exchange traders should be watching sterling pairs closely, both to make the most of short-term moves and also in anticipation of what could happen after the election. Yesterday’s inflation data suggested that, while political factors are important, important economic releases can be much more significant short-term drivers of sterling. Traders should note the full economic calendar this week with both Bank of England minutes and unemployment out today, public finances out tomorrow and the preliminary first quarter GDP figures on Friday morning.

The pound should find some resistance against the dollar above the $1.5500 level in the short-term, says CMC Markets’ Michael Hewson. There is trend line resistance drawn from the highs of 17 February. Also, the 38.2 per cent Fibonacci retracement of the decline from the November highs to the lows in March is sitting at 1.5560/80.

Combined, these technical indicators will make it difficult for cable to initially make significant advances – although strong first quarter GDP data could prove a sufficient catalyst.

Looking beyond the election, Kenneth Broux, senior market economist at Lloyds TSB, says that the popular view that a hung parliament would be bad for sterling does not stack up, at least not for the first month after the ballot.

The performance of sterling-dollar in 1974 – the last time there was a hung parliament – underlines that the pound can rally even if we don’t get a clear one-party majority on 6 May and the three main political parties are instead forced into negotiations over a coalition government. (See graphic below.)

A more hawkish Bank of England – which could be prompted by yesterday’s inflation figures – and stronger economic data would support sterling against the dollar in the medium-term.

Against the euro, Hewson reckons that the pound should stay strong even if the Lib Dems continue to make headway. “While below the 200-day moving average, the euro should drift back towards its nine-month trend line, which currently comes in around £0.8680.” But he warns that if the euro was able to close above the pair’s 200-day moving average, then the picture could change quite rapidly and the euro strengthen sharply.

Nick Clegg’s new-found popularity might spell bad news for sterling in the very short-term, but over time the performance of the economy will drive the currency, not voters’ political whims.