City Fears Hung Parliament -- but This Is No Need for Sterling Panic; ECONOMICS ANALYSIS

Article excerpt

Byline: Hugo Duncan

THE prospect of a hung parliament for the first time in nearly four decades has sparked talk of a sterling crisis. The narrowing of the opinion polls -- the Conservative lead over Labour has dropped into single figures -- suggests neither party will win an overall majority in the upcoming general election.

Investors are dumping the pound as a result. They hate the uncertainty and fear that a hung parliament would prevent or delay the action needed to slash Britain's crippling debts.

Failure to tackle the deficit run up by Gordon Brown -- borrowing is set to hit a record [pounds sterling]178 billion this year -- would threaten Britain's prized AAA credit rating, raise interest rates, and hammer the pound.

The last hung parliament in 1974 was soon followed by an embarrassing bailout by the IMF and currency analysts at Japanese bank Nomura warn a similar result in this year's election "would be highly negative for sterling".

Nomura's Alastair Newton says: "The Government would be considered guilty until proven innocent and could demonstrate an ability to push through difficult and contentious spending cuts and revenue enhancements. In this environment, we cannot dismiss the possibility of a sterling crisis, although we are hopeful that cooler heads will prevail and the UK will find a way to muddle through."

Newton says the election, expected on 6 May, will be a "watershed moment" for the UK in terms of how it is viewed in the financial markets. He argues that it does not really matter which party wins so long as the election results in a Government with a working majority strong enough to mend the nation's battered finances.

It is a popular view. "There is a real fear over the budget deficit and whether it will be tackled with a hung parliament," says Jane Foley, research director of online currency trader Forex.com. "There is no let-up for sterling." Citigroup chief economist Willem Buiter, a former member of the Bank of England's monetary policy committee, adds: "All bets are off should there be a hung parliament. Fiscal tightening could be postponed. The markets would attack sterling."

Indeed they might, and sterling would no doubt fall in the wake of a hung parliament.

But is there any justification for this? Cooler heads suggest not. Jonathan Loynes of Capital Economics says: "There are worries that a hung parliament could lead to higher interest rates and a lower credit rating -- a nasty scenario for sterling assets. …