Better public finance data may be sterling Trojan horse

March 19, 2010

Jane Foley
- Jane Foley is research director at Forex.com. The opinions expressed are her own.-

Finally UK monthly public finance data has brought better than expected news.  Not only was the net borrowing figure for February  better than expected but the January data was revised lower from 4.3 billion pounds to just 43 million pounds, taking the total for the fiscal year to date 131.9 billion pounds.

The better numbers mean that Chancellor Alistair Darling is on course for meeting, or perhaps even undershooting, his forecast of 178 billion pounds for the full fiscal year to April.

In essence this appears to be good news, but it requires qualification.  Firstly, these may be better than expected data but they are a far cry from good data.  At this stage last year the borrowing requirement was around half the size at 66.5 billion pounds; meaning that public finances are very much still in a shockingly poor position.

Not only that but there is risk that Darling will use the news that the borrowing requirement is set to come in under his (very high) target to announce some pre-election sweeteners during the March 24 budget.

The huge UK budget deficit (around 12.9 percent of GDP) is already a nasty thorn in the side of sterling and UK financial market sentiment, additional spending would not be welcomed by investors.

The recent falls in the value of the pound vs the dollar are correlated with the fear that the general election (expected to be called early May) will provide a hung parliament.

The optimal outcome from the election as far as the markets are concerned would be a clear majority for the Conservative party insofar as this is more likely to bring a quicker resolution to the worries surrounding the huge UK budget deficit.

Recently, there have been signs that the Conservative party’s lead in the poll could again be increasing (albeit by probably not enough to win a clear majority) and this has supported the pound.

Sterling posted gains on the news that the February borrowing requirement data were better than expected.  However, these gains are likely to be quickly reversed if the Labour party picks up more votes as the result of a pre-election giveaway at the March 24 budget.

In the absence of clear evidence that the incumbent government is committed to tackling the budget deficit, sterling is likely to remain on the back foot vs the dollar.

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