Counting On The Pound Is Dangerous. By Nicholas Hastings

Buying sterling now remains a very risky business.

The pound may be rebounding on the latest recovery in the U.K. labor market and signs that the country's public finances are starting to improve.

However, this will only boost the government's chances of re-election just as the Conservatives were pulling ahead in the opinion polls. If that is the case, then the risks of a hung parliament will rise once again, posing a fresh threat to the pound.

Over the last week, the pound has staged a relatively solid recovery back over $1.50, not only because the Conservative Party's lead over Labour bounced back to nine points from two points two weeks ago, but also because the Bank of England appeared to be taking a slightly more hawkish line--suggesting for the first time since the start of the credit crunch that the pound's recent weakness could have inflationary consequences.

See the pound's recent recovery:


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Up until this week, the central bank appeared to be quite happy to let the currency fall and make U.K. exports more competitive.

Hopes that the economy might be starting to pick up also came from much better-than-expected labor market data this week. This showed that the number of people claiming unemployment benefit fell last month by the largest amount since November 1997.

Although the headline data didn't show the sharp decline in the actual number of people that are employed in the U.K., the figures are being seen as evidence that the U.K. labor markets are flexible and will help the economy to recover more quickly than its euro-zone neighbors.

The government got further support from Thursday's deficit figures for February. Although these showed that public-sector net borrowing set a new record at GBP12.4 billion, the total was less than the market had feared.

Of even more importance, this means that the government may well undershoot its GBP170 billion deficit target for the financial year as a whole and provide Chancellor Alistair Darling the opportunity to produce a more vote-catching budget next week.

As Jonathan Loynes, chief European economist with Capital Economics in London, said: "He now looks likely to have a little wriggle room in the budget to either cut borrowing or fund a few pre-election sweeteners--we suspect that he will choose the latter."

With the government like to fully exploit the data in the run up to the election in early May, the Conservatives may well find that their lead in the opinion polls starts to fall back again.

It was just such a dive in the polls earlier this month that sent the pound hurtling down to its recent low under $1.47.

There is little reason why this won't happen again, especially since lending data from the Bank of England Thursday showed that tight credit conditions remain and that the country's recovery is very much at risk.

"This keeps open the possibility that the Bank of England could revive quantitative easing, especially if the economy shows serious signs of faltering over the next few months," warned Howard Archer, chief U.K. economist with IHS Global Insight.

Early Friday in Europe, the pound was a little lower--falling to $1.5190 by 0745 GMT from $1.5248 late Thursday in New York, according to EBS.

Reports that Germany is now supporting Greek plans to seek aid from the International Monetary Fund didn't prevent a small recovery in the euro as investors covered shorts ahead of the weekend.

The euro is up at $1.3617 from $1.3611 and at Y123.29 from Y122.94, while the dollar has risen to Y90.53 from Y90.33.