July 14 (Bloomberg) -- The pound may lose this year’s gains against the dollar and the euro should the U.K. fail to reign in spending and interfere with the Bank of England’s independence, UBS AG said.

The U.K. currency has been the best performer in the past three months among its 10 counterparts from the major industrialized nations after plunging to a 23-year low of $1.3503 in January. The U.K. may lose its AAA debt rating as the government’s net general debt burden approaches 100 percent of its gross domestic product, Standard & Poor’s said May 21.

“Currency markets are not pricing in risks that sterling faces over the next year,” Mansoor Mohi-uddin, Zurich-based chief currency strategist at UBS AG, the world’s second-largest currency trader, wrote in a report yesterday. “The currency is likely to remain a sell on rallies now after its sharp rally.”

The pound traded at $1.6273 as of 7:20 a.m. in London and was at 86.06 pence per euro.

The currency slid 27 percent against the euro and 32 percent versus the dollar in 2008 as the U.K. economy sank into a recession, spurring the central bank to cut the benchmark interest rate to a record low and print money to buy government debt and other assets.

Gross domestic product slumped 2.4 percent in the first quarter from the prior three months, the most in 50 years, the Office for National Statistics said June 30.

‘Fair Value’

The pound’s decline in 2008 returned the currency to its real trade-weighted exchange rate of the 1970s, which could be its “new fair value” as the U.K. becomes a net oil importer and is less able to rely on financial services to earn foreign exchange, Mohi-uddin wrote.

“Even without an outright crisis the conduct of economic policy will remain highly challenging as the next elections loom and politicians face persistently high rates of unemployment,” he said.

The number of Britons claiming jobless benefits rose by 41,300 in June, after increasing by 39,300 in May, according to a Bloomberg survey of economists before the government report tomorrow.

The U.K. and Argentina are the only members of the Group of 20 that can’t budget for temporary spending increases next year to aid economic growth, the Sunday Telegraph reported July 12, citing the International Monetary Fund.

Former prime minister James Callaghan asked the IMF for a loan in 1976 as the pound tumbled by 16 percent against the dollar. Callaghan’s time in office was marked by a surge in inflation and disputes between government and unions that triggered a series of strikes in 1978 known as the “Winter of Discontent.”

“In 1976 the pound collapsed because policy makers failed to tighten fiscal policy as the economy recovered,” Mohi-uddin wrote. “This caused investors to flee sterling as they became unwilling to fund the U.K.’s fiscal and current-account deficits.”

To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net.

Last Updated: July 14, 2009 02:27 EDT