UKIP Victory Fuels Pound Alarm as EU Debate Sets Election Tone

A second electoral victory for the U.K. Independence Party is putting the pound in the crosshairs with a general election due in less than seven months.

Sterling fell against most of its 16 major peers today after the anti-European Union party won a by-election forced by the defection of a member of parliament from the ruling Conservatives.

Amid speculation UKIP’s growing support will influence government policy on Britain’s ties with its biggest trading partner, Investec Asset Management said it is looking to buy options to sell sterling. Standard & Poor’s head of sovereign ratings Moritz Kraemer said membership of the EU is an “integral” part of the company’s assessment of Britain, while Societe Generale SA said sterling may plunge as much as 10 percent if the U.K. decided to leave the 28-nation bloc.

“A swing toward a party which is committed to leaving Europe and which could conceivably represent the balance of power is immensely significant,” said Kit Juckes, global strategist at Societe Generale in London. “It will be perceived as adding to uncertainty about the U.K.’s membership of the EU. If the U.K. were to leave the EU, our view is that would be negative for sterling.”

The pound fell 0.1 percent to $1.5680 at 4:14 p.m. London time, its first decline in three days, approaching the $1.5590 14-month low set on Sept. 6. It depreciated 0.7 percent to 184.30 yen. U.K. government bonds advanced.

Reckless Victory

Mark Reckless’s victory in the seat of Rochester and Strood, 30 miles (50 kilometers) southeast of London, follows that of fellow defector Douglas Carswell on 0ct. 9, prompting speculation further Tories who are against Britain’s membership of the EU will also switch allegiance.

The rise of UKIP, which also favors curbs on immigration, increases the possibility it will influence the complexion of a coalition government should no party win an overall majority in May’s general election. Prime Minister David Cameron has sought to stanch a drift of support from Tories to UKIP by pressing his pledge for a referendum on leaving the bloc and hinted he’ll seek an end to the free movement of Europeans into Britain.

“If the U.K. were to leave the EU, this would be detrimental to the British economic prospect,” Kraemer said in a Bloomberg Television interview. “Membership of the EU is an integral part of our assessment of Britain.”

Farage Response

UKIP leader Nigel Farage countered suggestions an EU pullout may deter investment into the U.K., citing a survey he said showed a go-it-along Britain would remain attractive.

“In North America and the Far East, two out of three investment companies said if Britain was outside of the EU, freed of much of the regulatory burden, they may well invest more money still,” Farage said in an interview on Bloomberg Television’s “Countdown” with Anna Edwards.

Sterling advanced against the euro after European Central Bank President Mario Draghi said policy makers must drive inflation higher as soon as possible, and will broaden the institution’s asset-purchase stimulus program if needed. The pound strengthened 1 percent to 79.12 pence, its biggest one-day gain since Feb. 12.

The increased chance of a hung parliament and risk of the U.K. leaving the EU will affect the pound more than gilts, which are being driven mostly by monetary policy, said John Stopford, head of fixed income at Investec Asset Management which manages around $123 billion.

Short Bias

“We have a bias to play sterling from a short side against other currencies to look for an opportunity to run an underweight position,” said Stopford. ‘We will also be looking at option strategies to buy insurance against a market surprise in May -- an option to sell sterling in terms of currencies.’’

A short position is a bet an asset’s value will fall. Underweight means that a fund holds fewer of the securities than recommended by the benchmark it uses to track performance.

Ten-year gilt yields declined four basis points, or 0.04 percentage point, to 2.05 percent. The 2.75 percent bond due in September 2024 rose 0.395, or 3.95 pounds per 1,000-pound face amount, to 106.17. Two-year rates dropped three basis points to 0.55 percent.

Gilts stayed higher after a report today showed the U.K. budget deficit widened as the economic recovery fails to lift income-tax receipts.

Net borrowing excluding public-sector banks was 64.1 billion pounds between April and October, 6.1 percent higher than a year earlier, the Office for National Statistics said. In October, the deficit was 7.7 billion pounds as capital investment rose, matching the median forecast in a Bloomberg survey and 200 million pounds lower than a year earlier.

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