IS the UK the next Greece? Some analysts in the currency market are starting to think so. Last weekend’s revelations that the former Labour government boosted spending by £12bn in the final days of its administration pushed cable to fresh yearly lows of $1.4250. With a budget deficit of nearly 12 per cent of its GDP, the UK may be the speculator’s next target.
Although the currency market cheered the Conservative-Liberal Democrat coalition, it was the shortest celebration in recent memory as traders quickly realized that David Cameron will have to raise taxes and implement massive austerity cuts that could depress the UK economy. Credit markets have already grasped this idea and last week traders pushed UK credit default swap rates higher as credit risk premiums rose.
Unlike Greece, the UK is in no danger of defaulting on its debt, but the prospect of slower growth and massive budget deficits in 2011 could force the Bank of England to revive its quantitative easing program – a move that is sure to push cable lower if it were to occur.
To make matters worse, the UK remains highly dependent on the financial sector, which is at risk from major changes in regulation. The well-worn phrase, “Sell in May and go away”, could apply not only to stocks but to sterling as well. If global capital markets go into a swoon as the summer progresses then downward pressure on cable is likely to increase.
With market sentiment so heavily skewed against it – the latest positioning data from US Commodities Futures Trading Commission show that speculators have amassed a record short position in sterling – the pound may well bounce this week as traders rush to cover their positions. Longer term however, the UK faces a very toxic combination of sovereign debt and capital market risk that could push sterling below $1.4000 and a possible re-test of 2008 lows at $1.3800. Although recent economic data from UK has been surprisingly positive, the events of the past several weeks may have done irreparable damage to the currency going forward.
Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail email@example.com.