Our view
Nov 08 - Where now for sterling after the Pre-Budget Report?
Haydn Davies, Aviva Investors strategist, comments: "After what commentators have described as the most politically-driven Pre-Budget Report of recent times, the market has begun to digest the details of Chancellor of the Exchequer, Alistair Darling's, fiscal proposals and its possible effects on the pound.
"In the wake of Monday's announcement, the pound fell briefly against the dollar but remained unchanged against the euro as it emerged the UK, under Mr Darling's proposals, would hold the largest deficit of the G7. Government plans to sell a further £37 billion of debt this fiscal year also weighed on sterling.
"By the morning after the announcement, the pound had further fallen to $1.507 from the previous day's close of $1.518. Sterling's declines, however, proved short-lived as the market appeared to give Mr Darling credit for taking steps to soothe the effects of what is likely to be a bruising recession.1"
Aviva Investors view:
While the Chancellor's growth forecasts seem highly optimistic, we believe the contents of the Pre-Budget Report and plans to claw back some of the spending pledges of the last Budget indicate the government has come to terms with the harsh realities of the slowdown.
The market appears to have acknowledged Mr Darling's efforts to pull back public spending and boost revenues from tax and national insurance contributions. While these moves are unlikely to affect the overall economic picture, the government has done just enough to allay concerns about the UK's ability to withstand the downturn.
UK government debt will hit 57% of national income by 2013 and, while this is the largest in the G7, we do not believe the UK's fiscal position is too far out of step with its peers. Debt levels proposed in the Pre-Budget Report are staggering but most of the world's developed economies are in much the same boat.
In the US, for example, President-Elect, Barack Obama, is believed to be drawing up a massive fiscal stimulus plan similar to Mr Darling's. All eyes are now on the European Central Bank (ECB) which has been reluctant to take decisive fiscal action in response to events.
While the Pre-Budget Report had no lasting adverse effect on sterling, the currency could still be in for a tentative few months. The next pressure point for the currency could occur when the Treasury moves to sell the extra £37 billion worth of gilts announced in the report. The market is already starting to question whether investors have the appetite to buy up these bonds.
Any problems shifting this record issuance could plunge sterling into dangerous territory. In our view, however, this is unlikely to happen given the strong demand for bonds in the present climate.
According to purchasing power parity calculations, the pound looks undervalued despite the government's high level of borrowing. On our analysis, the euro is currently overvalued and, with the ECB continuing to sit on its hands, we believe a normalisation of both currencies is likely to occur in the medium term.
-ends-
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Jane Reynolds
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Notes to editors:
1 Source: Bloomberg
The opinions expressed are based on Aviva Investors internal forecasts and should not be relied upon as indicating any guarantee of return from an investment managed by Aviva Investors.
The source for all information is Aviva Investors as at 26 November 2008, unless state otherwise.
Aviva Investors
Aviva Investors is the global asset management business of Aviva plc, the world's fifth-largest insurance group. The company operates under a single brand with more than 1,100 employees in 21 locations across North America, United Kingdom, Europe, and Asia Pacific.
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