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Analysis
Worries ahead for sterling

Worries ahead for sterling

Haven status under review
Threat for Cameron if strategy comes unstuck

by David Marsh

Mon 28 Jan 2013

British officials of varying hues in recent months have made no secret of their distaste for the pound’s moving above €1.20 at a time when the UK economy has been in the doldrums. After sterling’s slide in the wake of disappointing fourth quarter UK growth numbers, and in view of a new mood of relative optimism about the euro, the British government is likely to achieve its wishes – a significantly weaker exchange rate in coming months. The reappraisal of sterling’s fortunes may not all be plain sailing.

With sterling down to €1.17, the currency looks under way to be losing its ‘safe haven’ status.

David Cameron, the prime minister, has already embarked upon a high-risk strategy with his announcement of a possible referendum in 2017 on UK membership of the European Union.

Last week his calibrated gamble on Europe enjoyed a better response than many had expected. German Chancellor Angela Merkel refused to condemn Mr Cameron’s move and even awarded his European reform plan some words of cautious approbation.

But the prime minister’s strategy could fall apart if the UK economic slowdown turns into a full-scale recession. This could herald a run on the pound and a slide towards parity with the euro. The outcome would be a sharp fall in foreign asset managers’ propensity to buy government bonds, and a hugely damaging U-turn in the ‘austerity-first’ economic strategy of George Osborne, the chancellor of the exchequer. If Cameron is unlucky, he could face a leadership challenge before the next general election, due in 2015.
 
Friday’s news of a 0.3% fall in Britain’s output – pushing the economy closer to a so-called triple-dip recession – spoiled what had otherwise been a relatively good week for Cameron. By agreeing to demands from his Conservative party for a plebiscite on UK adhesion to the EU, but clothing his call for EU reform with generally pro-European rhetoric, the prime minister accomplished a tricky balancing act.

He mapped out a genuine route to a more competitive and (ultimately) prosperous EU better able to cope with the imperatives of globalisation.

But the Cameron plan could be confined to academic history if he is unfortunate enough to be dispossessed before the next election. Boris Johnson, the mayor of London, is Cameron’s most serious potential challenger-in-waiting. He confronted the prime minister last week by advising the government to ‘junk talk of austerity’ and heavily increase investment in infrastructure.

The only possible route for Johnson to secure the Conservative party leadership and, in its wake, the mantle of prime ministership lies in widespread disillusionment with the government’s orthodox economic course. Bank of England governor Mervyn King, an earlier devotee of the government’s deficit-cutting strategy, last week underlined his disappointment with the course taken so far, urging the government to take supply-side measures to get the economy going again.

If the atmosphere in the Conservative party becomes increasingly fraught, no amount of careful understanding from Chancellor Merkel for Cameron’s European proposal could avert the prime minister’s fate. Another spell on the opposition parliamentary benches would beckon. If the pound falls too sharply, this could be the denouement. British officials must be careful what they wish for.

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