LONDON: If Italy’s general election does deliver political gridlock, a big loser could be sterling, with arguably the best move being to sell it against the dollar.
Traders may see the post-election slide in the value of the euro against sterling to levels under 86 pence as the real driver of the pound’s simultaneous bounce against the dollar and take the view that the move against the greenback is unsustainable.
The chance to sell sterling against the dollar at levels near or just above $ 1.5200 could prove attractive for dealers who may yet see the pound sink below $ 1.5000.
The risk is that a resurgence of tensions in the euro zone delivers the “wrong” kind of sterling fall, thereby worsening the outlook for the British economy, and triggering even more sterling weakness against the dollar.
While no Italian political party has secured an outright mandate to govern in the bicameral legislature, more than half of Italy’s voters backed parties that rejected the austerity policies of the outgoing Mario Monti-led government.
That rejection, on top of the overall election result, has scared investors, prompting them to sell the euro broadly and to dump Italian and other peripheral euro zone debt.
Such a development is bad news for Britain where the Bank of England has previously appeared supportive of sterling weakness as a way to rebalance the stagnant UK economy.
In truth, the optimal solution for British policymakers would probably be for the main expression of sterling weakness to be against the euro, given the importance of the euro zone as a market for UK exporters.
Depreciation of sterling against the dollar is arguably less attractive as it increases price pressures by raising the costs of importing energy, which is priced in greenbacks.
Unfortunately, the Italian election deadlock might, at least temporarily, scupper any hopes that the euro/sterling exchange rate could carry the weight of any depreciation in the pound’s value, and in fact could deliver the worst of both worlds.
It has become more difficult to portray Britain as a safe haven outside a euro zone beset by economic challenges.
With Britain suffering its first sovereign credit rating downgrade from a major agency on Friday, when Moody’s stripped the country of its coveted triple-A rating, sterling had already come under pressure.
But the Italian result has complicated matters, even though the broader argument for sterling weakness remains intact.
If investors want to sell sterling against the euro but feel constrained by euro zone-specific factors, they may just sell more pounds against other currencies, with the liquid sterling/dollar market the most likely conduit. The risk is that while the British government sticks to its austerity plans, the UK economy is simultaneously hit by imported energy price inflation which saps economic activity, exacerbating the sense of stagnation.
That would just result in investors taking an even dimmer view of prospects for the British economy and thus for sterling.
— Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own.
