Sterling recoups huge losses amid hopes of deal

STERLING and gilts recouped early massive losses yesterday, after initial jitters about the inconclusive outcome to Britain’s election eased on prospects of a deal between the Conservatives and Liberal Democrats.

Imminent talks between the two main centre-right and centre-left opposition parties boosted chances that politicians will be able to agree soon on deficit-cutting plans – vital for markets given a turbulent international backdrop that has sent shares tumbling.

The FTSE-100 index of top British shares closed at a six-month low of 5,123, down 2.6% on the day after a 3.9% fall by its European counterpart driven by worries about the risk of a Greek government bond default.

The spread between British and German government bond yields – a barometer of how worried investors are about the British fiscal outlook – hit its highest in at least 12 years at 124.8 basis points, but by late in the day was almost unchanged versus late Thursday at 102 basis points.

Gilt prices ebbed and flowed based on televised statements by Prime Minister Gordon Brown, head of a caretaker government now his Labour Party has lost its majority, Tory leader David Cameron and Liberal Democrat chief Nick Clegg.

“Cameron’s ‘big, open’ offer to Clegg helped to contain the bloodbath in gilts at least in part ... (but) the formation of this coalition could be a very slow process and the market will not like that,” said Matteo Regesta, fixed income strategist at BNP Paribas.

The June gilt future had the highest daily trading volume for a front-month long gilt future since the derivative’s launch in 1982 as well as the widest trading range since the Bank of England started quantitative easing last year.

“The comments from Clegg and then Cameron gave sterling some relief, but ... questions remain over whether the Conservatives and the Liberal Democrats can work together,” said currency strategist Audrey Childe-Freeman at Brown Brothers Harriman.

An outright win for the Conservatives had been seen by many investors as the most beneficial outcome for both sterling and British government bonds, given the centre-right party’s tough talk on cutting the deficit.