Monday, March 1, 2010

Expectations and their Effect on the Exchange Rate

The pound has hit another low - this time a 10-month low - against the dollar.  The BBC news article suggests that this low is caused by raised expectations of a hung parliament - i.e. no party gaining a majority after the upcoming election.

A poll published today has cut the Tory lead to just two points, the lowest it's been for two years.  Polls are well known for their lack of accuracy, and over the last two years I've been hoping the polls are wildly inaccurate, hoping for anything but a Tory win.  Betfair is a betting market, and allows bets to be placed (and laid) on all kinds of events, including the forthcoming general election.  Over there, the Tories are still well ahead, and even the probability of no overall majority isn't so high, at only 30%.  Who is right?

Either way, the point is that expectations in the markets have affected the exchange rate.  Earlier on the lecture we talked about how expectations might cause unstability in markets: For example, here demand for pounds and supply of pounds is affected by something other than the price of the pound (the exchange rate): By the expectation of a hung parliament, and all that entails.

A hung parliament means that neither party has a majority, and hence policy-making becomes very difficult, since neither party really agrees on things, in particular the way the deficit should be addressed.  Most likely is delayed legislation, and a lack of clarity, which is the last thing that is needed when those lending to the UK government are seeking exactly that: Clarity on when the deficit will be tackled.

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