The political dangers to sterling

“Tory win best for economy say top bankers” screamed the Telegraph’s Friday splash headline (online, the story was downplayed and detailed, wierdly). The “top bankers” in question were Deutsche Bank’s London strategy team – great strategists, but perhaps surprised to find themselves labelled thus. Quibbles aside, a detailed strategy report from DB suggests a Tory government with plans for faster cuts to the deficit would be likely to be better for sterling, might help prevent a downgrade of the country by ratings agencies and could result in lower interest rates. Here’s what Jim Reid says in the report:

The best result for UK equities is likely to be an outright victory for the Conservative party. Although an outright Labour victory would help create certainty, the lack of urgency in their deficit reduction plans may be negative for Gilt yields and may alert the rating agencies. If Gilt yields aren’t negatively impacted by a Labour victory then their ‘spending for longer’ policy may actually be better for markets than a Conservative administration committed to fiscal cutbacks.

But the actual deficit policies from the Tories, the report accepts, don’t look much different to Labour over the term of the next parliament – the Tories have just said they would bring the cuts in sooner.

In practice, both sides are likely to cut deeper than they have so far admitted, even without a sterling crisis. But it is worth looking again at what the Tories are promising. A document put out to the press last week, but not released more widely, suggests the Tory plan for “faster” cuts amounts to nothing more than a one-off cut equivalent to 0.5 per cent of GDP – in effect bringing down the national debt by £6bn, or 0.7 per cent (one-off, because from 2011 onwards the savings would be used to reduce the planned rise in National Insurance). Aside from the (valid) questions over the Tory plans to fund the cut by efficiency savings, this just isn’t enough in the context of an annual structural budget deficit of 8.4 per cent. Here’s what the Conservative briefing document for the press said of the planned cut:

This is just under 0.5% of GDP and less than 1% of total Government spending. It is the result of a twin assessment of what is necessary in order to retain Britain’s credit rating and restore confidence in our economy, and what is achievable in-year without affecting the quality of front line services…

Our judgement is that this is the right amount of additional in-year savings needed to establish credibility and restore confidence in our economy.

Now, would that information change the DB assessment of the impact of different parties winning? My guess is not: as Reid told me, the market reaction is about the perception of party ideology, not about actual policies.

“The belief is that Labour stands for spending for longer,” he said. “And of course perception is reality in financial markets.”

As an aside, Morgan Stanley on Friday agreed with DB on the effects a Tory or Labour victory would have, in a note from the bank’s strategy team:

Investors are likely to react most positively to an outright Conservative victory, with sterling and gilts likely to rally on the expectation of more aggressive fiscal tightening and less regulation.

In our opinion, investors likely have lower confidence in the current government’s willingness to tackle the budget deficit than they do for the Conservatives. Rightly or wrongly, this would likely prompt an initial sell-off in sterling and relative underperformance of gilts if Labour were to remain in power.

Morgan Stanley’s strategists, led by Melanie Baker, take a different line to DB on a hung parliament, though: they believe it could result in more cross-party agreement on deficit reduction (DB is very worried about a possible second election disrupting plans for cuts).

Either way, the message from the City is clear: vote Tory if you want to see your investments prosper. It is a shame that perceptions are so much more important than policies, but it has ever been thus. Mind you, if policies mattered, the recommendation would probably be to vote against all of them.

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Christopher Cook is an FT editorial writer. Before joining the FT in 2008 as a Peter Martin Fellow, he worked for three years for the Conservative party.

Lorien Kite is deputy comment editor, a post he took up in 2009 after four years as a commissioning editor on the analysis page. He joined the FT in 2000.

Ian Holdsworth became assistant features editor in 2009 and was previously chief production journalist for the features pages.


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