Swine Flu May Push The Pound Over The Edge. By Nicholas Hastings

Sterling is strolling to the edge of the precipice and swine flu could well push it over.

For weeks now, the pound has been looking vulnerable.

Britain's economic recovery is showing signs of faltering and warnings over the size of the government's budget deficit have been legion.

But, with global risk appetite remaining high and worldwide equity markets remaining buoyant, the pound has failed to suffer.

The currency has just bounced around between $1.60 and $1.65, with investors showing little sign of moving out at this stage.


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Nevertheless, downward pressures on the currency are rising and cracks in market confidence are starting to appear.

Last week, sterling simply didn't get the lift that might have been expected from the strong second-quarter earnings reports from the U.S. financial sector and the general rise in global market sentiment.

"The disappointing performance of sterling despite the favorable market environment suggests that sterling/dollar will become vulnerable once conditions deteriorate again," said Ian Stannard, senior currency strategist with BNP Paribas in London.

Certainly, the background news isn't helping.

Although the Bank of England failed to extend its quantitative easing program as many had hoped earlier this month, it now looks as if the bank will still do so next month. In fact, analysts said the latest minutes from the bank this Wednesday could show that it is preparing to extend QE by even more than the GBP25 billion that was initially expected.

Concern over the country's fiscal position is also rising, with the International Monetary Fund now joining the chorus of critics. In a report last week, the fund warned that the government needs to come up with a "credible plan" for improving public finances if confidence in the U.K. is to remain.

"Market conditions suggest the U.K. has been getting the benefit of the doubt, both in the government bond market and also the foreign exchange market," the fund said.

The IMF report has added to the negative pressures on sterling, especially as the government is unlikely to suggest any cuts in public spending ahead of what is likely to be a fiercely fought general election next year.

However, the trigger for some nasty correction in the pound could well come from a different direction as swine flu gradually returns as a major issue for the British economy.

Over the last week or two, deaths from the flu have risen sharply, with the National Health Service now forecasting 65,000 deaths with as much as 30% of the population coming down with the symptoms.

Oxford Economics reckons this could wipe 5% off the country's GDP and delay the economic recovery for two years as consumers avoid shops and restaurants and businesses postpone investment plans even further. The uncertainty could add to the woes of the financial markets and push interest rates higher despite the weakness of the economy.

Then the pound, which is now just looking over the precipice, will more likely find itself falling down it.

Early Monday, a rebound in risk appetite is helping most high-yielders, including the pound, higher. News that CIT Group has got a rescue package that will save it from bankruptcy and anticipation of more strong second-quarter earnings from the U.S. later this week are both helping to lift market sentiment.

At 0645 GMT, the pound is up at $1.6408 from $1.6357 late Friday in New York. The rise came as Rightmove reported that house prices rose by 0.6% this month, taking the fall on the year up to -3.1% from -5.5% in June.

The dollar is up at Y94.72 from Y94.34, while the euro has risen to $1.4161 from $1.4098 and is up at Y134.18 from Y133.00.