After sharp dips following the election, sterling stabilised on Friday in the expectation that a political deal would be struck over the weekend, with the Conservatives forming a government with the backing of the Liberal Democrats. Yesterday, however, Tory sources said no deal was likely before tomorrow, though progress was being made.
Traders said markets were already spooked by the chaos in America on Thursday, when prices plunged crazily before recovering most of their losses.
The Securities and Exchange Commission and other market regulators have launched investigations, with initial explanations of a “fat finger” trade (a mistaken one) now discounted.
“With the markets being highly nervous … and in the mood to penalise any country that is perceived to be falling short on its deficit-reduction needs, it is of paramount importance that a credible commitment on how to tackle the dire UK public finances is in place sooner rather than later,” said Howard Archer, an economist at IHS Global Insight.
Michael Saunders, an economist at Citigroup, said: “The UK faces a difficult mix of political weakness and unsustainable fiscal trends. The electoral system — no fixed election date and first past the post — means minority governments tend to be inherently unstable. With the biggest budget deficit in the G7, Britain urgently needs to establish a credible path back to fiscal sustainability.”
Other City sources warned that bank liquidity — the willingness of banks to lend to each other — had dried up suddenly last week. “That is what caused the last crisis and is still the big worry,” said one senior banker.
The Bank of England postponed its regular monthly monetary policy committee meeting on Thursday to avoid a clash with the election. The meeting tomorrow is set to leave Bank rate on hold at 0.5% and not add to the £200 billion of quantitative easing.
Economists have warned that if political uncertainty sends the pound sharply lower, the Bank may be forced to put up rates sooner than is good for the economy.
Mervyn King, the governor, will present the Bank’s new inflation report on Wednesday. It is expected to point to higher inflation.
Today’s EU moves follow an aggressive market sell-off last week on worries about the Greek crisis spreading to Portugal, Spain and Italy. Alistair Darling will travel to Brussels today to attend the meeting.
The mechanism will include an arrangement to allow the European Commission to issue bonds with the implicit backing of the European Central Bank. Any default losses will be shared by all member states, including Britain. A European Monetary Fund will also be proposed, but is likely to be rejected by some member states, including Britain.
Some analysts fear events in the eurozone will tip the markets into a deep, enduring crisis. Others are more optimistic.
Brian Belski, chief strategist at Oppenheimer in New York, said fear was likely to continue causing havoc in the near term. “Everyone was bullish and now the world is coming to an end,” he said. Mistrust of the market was muddying investors’ vision, Belski said. “It’s a problem of optics. What is Greece? It’s 3% of the GDP of the eurozone.”