Sterling: the start of the collapse?

You know you're in trouble when even Zimbabwe dollars rise against your currency, says David Wighton in The Times. Sterling was walloped across the board on Monday, collapsing by 3% against the greenback in a matter of hours. It finished the day at a ten-month low below $1.50 and also fell to a three-month low against the struggling euro. Why?

A run of weak macroeconomic data in the previous few days notably a slump in business investment in the fourth quarter had revived speculation that the Bank of England would restart its money-printing programme to prop up the economy. Meanwhile, strong US quarterly growth figures foreshadow higher rates in the US. Monday's purchase by Prudential of the Asian operations of AIG also involved the sale of lots of pounds for dollars. But the key problem was a weekend poll showing that the Tory lead had shrunk to two percentage points.

Now that fears over Greece have abated, the markets are concentrating on Britain. The worry is that a hung parliament would make the odds of "any sort of credible fiscal plan" to slash Britain's huge deficit just after the election very slim, says Chris Iggo of Axa Investment Managers. That raises the spectre of a credit-ratings downgrade, higher long-term interest rates that would choke off growth, and a renewed sell-off in sterling and gilts as confidence dwindles. Gilt yields are on the rise, with the ten-year yield gap between German and British paper up by more than half a percentage point since November. So we already pay more to borrow for ten years than Italy.

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Foreign investors could ultimately refuse to plug our deficit, says Ian Campbell on Breakingviews.com. "A government with a Greek-sized deficit" and a depreciating currency "may find it hard to woo them". And it's certainly hard to see sterling recovering any time soon. The currency markets appear to have "run out of patience", so sterling could be "staring into the abyss", says Mark O'Sullivan of Currencies Direct.

This could well be "the beginning of sterling's collapse", agrees Nick Beecroft of Saxo Bank. Expect a fall to $1.40 soon as political uncertainty endures, he says. Investors should also expect a flight from risk as the global economy worsens. That will give the dollar a fillip. It's a combination that could push the pound down to $1.20 by summer.