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Pound Slides After Election Result Suggests Deficit May Not Be Tamed Soon

The pound sank the most in a year and a half against the euro and British bonds fell as the U.K. election failed to produce an outright winner, fueling concern that measures to tame the budget deficit will be delayed.

The currency dropped to a 13-month low against the dollar, posting a second weekly loss, after David Cameron’s Conservatives fell short of winning a majority in Parliament. Losses on 10-year gilts pushed the yield up by the most since October. Cameron said he wants to make a “big” offer to the Liberal Democrat Party to form a government. The FTSE 100 Index of stocks slumped 1.1 percent, pushing its decline since April 30 to 6.4 percent.

“People are increasingly taking fright as to the unfolding political backdrop,” said Jeremy Stretch, a senior currency strategist at Rabobank International in London. “That’s not a particularly ringing vote of confidence, and sterling is reacting accordingly as well.”

The pound fell 1.5 percent to 86.41 pence per euro as of 4:19 p.m. in London, after earlier dropping by the most since December 2008. It weakened 0.9 percent to $1.4704, after slipping to the lowest level since April 2009.

Liberal Democrat leader Nick Clegg said the Conservatives, who have pledged to cut the deficit more quickly than the other parties, deserve the first chance at forming a government. Clegg’s party is Britain’s third-largest and may hold the balance of power. The Conservatives “hope we can reach agreement quickly on the big, open comprehensive offer I have made today,” Cameron said at a press conference in London.

Photographer: Chris Ratcliffe/Bloomberg

A stack of U.K. one pound coins sit arranged for a photograph in London. Close

A stack of U.K. one pound coins sit arranged for a photograph in London.

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Photographer: Chris Ratcliffe/Bloomberg

A stack of U.K. one pound coins sit arranged for a photograph in London.

Yield Spread

Investors demanded an extra 1.04 percentage point, or 104 basis points, to hold 10-year gilts rather than German bunds today, according to Bloomberg generic data. The difference, or spread, was 57 basis points on Jan. 4.

The pound has declined 4 percent this year, Bloomberg Correlation-Weighted Currency Indexes show, amid concern a hung parliament would leave the government too weak to manage Britain’s 167 billion-pound ($245 billion) budget deficit. At more than 11 percent of gross domestic product, it’s the biggest shortfall in the Group of Seven nations. Conservative economics spokesman George Osborne said April 21 that the U.K. could be forced to appeal to the International Monetary Fund if the election produced an indecisive result.

‘Any Excuse to Sell’

The cost of insuring against losses on U.K. sovereign debt jumped, with credit-default swaps tied to the securities rising 8 basis points to 99. It earlier reached the highest in three months, according to CMA DataVision prices. The increase signals investors’ perception of the nation’s credit quality has deteriorated.

“Any excuse to sell sterling, traders will take it,” said Harry Adams, a currency trader at Schneider Foreign Exchange in London. “Ultimately markets don’t like uncertainty and we have a lot of it here. I don’t see this being sorted out quickly.”

With 642 results declared, the Conservatives had 302 seats in the 650-seat House of Commons, making it impossible for them to gain outright control. Labour got 256 and the Liberal Democrats had 56. The Conservatives gained a net 98 seats and Labour lost 91.

Standard & Poor’s affirmed its “negative” outlook on the U.K.’s AAA rating on March 29 “in the absence of a strong fiscal consolidation plan.” Moody’s Investors Service said Britain has moved “substantially” closer to losing the top rank as debt costs climb. Fitch Ratings said on March 24 that the pace of deficit reduction is too slow.

The 10-year gilt yield increased 3 basis points to 3.83 percent today, while the yield on the two-year note was little changed at 1.09 percent.

1974 Precedent

“We’re probably going to get less fiscal consolidation than the market hoped for, and that’s clearly a negative for gilts,” said Elisabeth Afseth, an analyst at Evolution Securities Ltd. in London. “This can’t be seen as a good result for anybody.”

Yesterday’s election was the first to produce no clear winner since 1974. On that occasion, it took four days before Conservative leader Edward Heath resigned as premier, allowing the Queen to name Labour’s Harold Wilson to head a minority government.

“Sterling is as clear a barometer as you can get about the need for a government with a clear mandate,” said Simon Derrick, chief currency strategist at Bank of New York Mellon Corp. in London. “It’s that level of uncertainty that’s weighing on sterling.”

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Paul Dobson in London at pdobson2@bloomberg.net.

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