Tories could be making sterling a rod for their own back

March 3, 2010

BRITAIN-CONSERVATIVES/Talking down the pound could have some pretty bad consequences.

Ever since the debacle of sterling being forced out of the European exchange rate in September 1992, British officials and politicians have maintained a stiff upper lip when talking about the pound.

The Conservative government spent billions of pounds and jacked up interest rates to defend the currency back then, but to no avail. The party’s reputation for economic competence was lost, paving the way for Labour’s big win in 1997.

The one lesson that everyone obeyed was there was no point trying to manipulate the currency because you could not buck the market.

I can only remember one occasion when Gordon Brown, chancellor of the exchequer for a decade before he became prime minister, made the kind of currency comment that news agencies and euro zone politicians love.

No one can be happy with an 18 percent rise in the pound, he said in 1997 soon after taking office. Since then, the British usually don’t even like repeating the standard G7 language on currencies, so scared are they of mayhem in markets.

Could the Conservatives be about to change all that? They certainly appear to be playing with fire. Former chancellor and current Conservative business spokesman Ken Clarke warned on Tuesday that the country could soon be facing another sterling crisis.

The pound’s fall this week, he said, had been a result of a poll showing the possibility of Gordon Brown staying on as prime minister. His party leader David Cameron and shadow Chancellor George Osborne were right next to him at the Thomson Reuters event.

Both other men have raised the spectre of Britain facing a Greek-style debt crisis or losing its triple-A rating unless greater action is taken on the deficit. Of course, this is pure politics given an election is expected on May 6 and the Conservatives must be worried by their once-impressive poll lead narrowing.

Former Labour leader Neil Kinnock told Reuters this week that people often don’t want to vote for change when economic conditions are bad. He should know — he lost the 1992 election when everyone had expected him to win because the economy was in such a dire state.

No wonder, then, that the Conservatives have turned their fire on Labour’s economic record. But talking down the pound can be a dangerous game, as currency markets are notoriously fickle.

While Clarke blamed the pound’s lurch lower on Monday on the prospect of a Brown victory, part of the reason for the currency’s decline was news that Prudential was going to buy AIG’s Asian life insurance business.

Reports that this might fall through has already given sterling a bit of a lift, but the bigger danger is that international investors start dumping the pound because even the people who are probably about to run the economy are talking it down.

Perhaps a sterling crisis before the election might play in the Conservatives’ hands. But markets obey no one’s timetable. The crisis could just as easily ensue on May 7 even if the Conservatives win.

They are setting a very high bar for themselves to bring down the deficit quickly without actually providing any details how this might happen. The markets could be disappointed yet.

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Indeed, surely the most likely moment for a real sterling crisis is when the markets decided that a weak new government is incapable of delivering the brutal cuts blithely promised in opposition – ie before cuts mean lay-offs, reductions in services, the abandoning of long-promised capital projects, etc.

Posted by MarkMorris | Report as abusive