The Effects of FX

The market's first reaction to the as-yet incomplete election result has not been promising for sterling. By the time London opened on Friday morning the pound was four cents lower against the US dollar and down by two against the euro, compared with its levels when the polling stations opened on Thursday. Clearly, investors are not overjoyed by the result. How can this be, given the months of warning from the opinion polls that there would be no overall majority?

Investors, like gamblers and football supporters, have a dangerous tendency towards optimism that can sometimes backfire on them. In the day or two before the election, and despite the polls still pointing to a hung parliament, that optimism led them to expect the outcome to be, if you like, better than expected. We now know that it was not. Parliament is jaw-droppingly well hung and nobody knows who will be occupying Number Ten in a week's time.

What worries investors now is the possibility that the occupant might still be Gordon Brown, not because they dislike or distrust him but because his position has been hugely compromised. A hung parliament under the management of a new prime ministerial broom offers- realistically or not - the promise of change and progress. One led by a still-unelected incumbent and handicapped by the demands of a coalition partner simply means less of the same. The worry is that the 'less' in this case would be less determination to reduce the nation's debt and less commitment to making the 'difficult decisions' necessary to prevent the UK going the way of Greece.

Had the result been a little more clear-cut, the pound would probably have come out of the election in better shape. It is not as if a hung parliament came as a surprise.But investors hate uncertainty. To be told that it may take ten days to form a coalition or minority government is one thing; to maintain enthusiasm for sterling throughout those ten days is quite another.

It is conceivable that investors will take a shine to a new prime minister if one emerges from the horse-trading, and that they will renew their support for the pound. It is less easy to imagine them throwing their hats in the air for the old one. In the meantime, uncertainty is likely to gnaw away at sentiment towards the pound.

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