A Forex View From Afar

The U.K. Dilemma

Even though the U.K. economy is shrinking at a very fast pace, around 1.5% in Q4, the U.K. Prime Minister gave in to the idea of a new stimulus package.

Currently, the country’s outlook is rather gloomy, having the most important economic indicators near record lows. Retails sales continued to decline in February, while sales of small stores dropped the most since 1986, when records first began. Mortgage approvals are holding barely above record low levels, while unemployment claims jumped in February the most on record sending the jobless rate to a decade high. Private forecasters have said that the U.K. economy will shrink between -3% and -4% this year.

Despite the very poor outlook surrounding the economy, the governments’ hands appear to be tied. Both the Chairman of the Bank of England (BoE), Mervyn King, and the Chancellor of the Exchequer, Alistair Darling, have expressed their concerns about the deterioration of the public finances.

On top of this, yesterday, the U.K. Treasury failed to sell all the intended gilts at auction for the first time in seven years. This shows that investors are finding the debt issued by the U.K. government overvalued.

Every time the Treasury fails so sell its debt, it adds an additional burden on the taxpayers’ shoulders as investors request higher yields to be paid. A new stimulus package would imply that the Treasury has to sell even more debt, something that would have a substantial effect on the gilt’s value.

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