Concerns over Britain's entry into the euro have led to sterling hitting its lowest level in 15 years
So far this year, the UK has enjoyed unique status among global markets, offering reasonable economic growth, a strong and stable currency, an outlook of interest rate cuts and persistently low inflation. Investors quickly fled the downturn in the US but many didn't feel confident enough about growth prospects in Europe to commit significantly. The UK has been a safe staging post.
Britain's benign economic environment has certainly been one of the reasons for Labour winning a historic second term of office. The party managed to convince even die-hard sceptics that its new right-of-centre bias is here to stay, whatever the protests from its traditional socialist supporters.
The election result should have removed any lingering uncertainty and provided a springboard for the market to move confidently higher. But instead, investors are experiencing an acute attack of unease, not to mention dÃ©jÃ vu. Where did a scenario of a weakening currency, creeping inflation, higher oil prices and menacing demands for public sector wage increases suddenly materialise from?
Sterling hit 15-year lows on the mere suggestion that the UK would be joining the euro sooner rather than later. The reaction was far sharper than expected, although the possibility is not exactly news.
The latest UK retail price inflation figure moved the market mood from caution to alarm. The Treasury warned that managing down the pound to facilitate entry to the euro was bound to stoke inflation. That somehow translated into an immediate assumption that further interest rate cuts were off the agenda.
Sterling faces a period of volatility. British manufacturers have been calling for a weaker pound to help make their products more competitive, but they hadn't bargained on a slide this early and of this scale. Now it emerges that both public and private wage claims are rising, while unemployment is still falling.
There are various good reasons behind each of these worrying indicators but their appearance all at once has triggered a panic attack among some investors. Parallels are being drawn with the 1970s, even though seasoned leftists admit there is absolutely no chance of a repeat of the economic chaos that ejected Labour from office two decades ago.
Trade union threats earlier this month of another 'winter of discontent' met with a robust Government response. But bravado is too often followed by capitulation. Tony Blair has a fine line to walk ' the Government has to keep a grip on public spending and wage claims but also needs the co-operation of the public sector to deliver promised health and education improvements. The present fever of speculation surrounding the timing of the pound's link up with the euro and the precise level when it does will cool, especially if a few speculators get burned on some sharp short-term currency moves. Long-term investors, especially domestic players, should realise that behind the present clamour of political noise, the UK remains fundamentally attractive.
Economic growth is still positive. Pre-election wage rises account for the blip in inflation, which remains below the Bank of England target range. Sterling's plunge reflects renewed disenchantment with the euro, not with the UK, so a monetary response is hardly appropriate. It would suit some narrow party political ends to suggest the UK economy is about to disintegrate, but the pleasant fact is, the home market still has an edge over most others worldwide.
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