DJ Forex Focus: Election Polls Leaving Sterling Vulnerable

Sterling is still waiting for reassurance that the Conservatives are going to win the May 6 election in the U.K.

If this doesn't come soon, a combination of widening yield differentials and increased investor concern about sovereign debt will make the currency even more vulnerable to a nasty fall against the dollar.

Since the general election was called just over a week ago, the pound has essentially levitated, with investors showing support on the assumption that the Conservatives will pull ahead in the polls and dispel any fears of a hung parliament.

See the pound's performance against the dollar:

However, there has been little sign of this happening just yet. Opinion polls continue to bounce around, giving Conservative leader David Cameron and his band of hopeful cohorts a lead of between six and eight points--enough to establish a majority in the House of Commons but not necessarily enough to ensure a strong enough administration to push through what could prove unpopular measures to reduce the country's budget deficit.

In the meantime, the whole issue of national deficits is hardly going away.

Hopes that last weekend's Greek bailout from the European Union and the International Monetary Fund would relax investor fears and reduce the cost of short-term Greek funding have proved to be illusory.

On the contrary, chances remain high that Greece could still default on its debt payments, especially if the cost of longer-term funding remains too high for the country to start reducing its deficit significantly.

Thus, sovereign debt is likely to remain right at the top of financial markets' concerns, putting the U.K. debt reduction plans, or lack of them, under even greater scrutiny than before.

For the pound, there has been some good news. This week brought news of a sharp decline in the country's trade gap.

But, this was driven largely by the recent weakness in the pound making U.K. goods more competitive abroad and the domestic economy remains weak.

In fact, other figures, such as the latest housing price figures, show that the property market is cooling off again. Also, consumer confidence appears to have dived because of uncertainty over the election.

This suggestion that the U.K. recovery is proving even weaker than anticipated contrasts with data from the U.S. in recent weeks, which are showing more signs of improvement.

The U.S. Federal Reserve is also seen edging closer towards some form of policy tightening--a move that will only increase the yield differential between the U.S. and the U.K. and make the pound appear even less attractive to investors in the future.

So unless polls start showing that the Conservatives are convincing the electorate that they have what it takes to lead the country, sterling could find itself on an even more slippery slope than it might have been before.

Early Thursday, the pound showed its sensitivity to the latest opinion polls by posting gains after a new poll showed that the Conservatives were leading Labour by 12 points in crucial marginal constituencies.

This comes ahead of a televised debate between the leaders of all three parties tonight. This is the first time such a debate has been held in the U.K.'s political history and could prove decisive in the election.

The pound has risen to $1.5520 from $1.5469 late Wednesday in New York, according to EBS.

Elsewhere, general market sentiment was lifted by a combination of strong retail sales in the U.S., strong first-quarter growth in China and continued dovish comments by Fed Chairman Ben Bernanke suggesting that the Fed isn't about to strat tightening policy yet.

The dollar is up at Y93.28 from Y93.18, while the euro has slipped to $1.3647 from $1.3657 but risen to Y127.34 from Y127.28.

Bloomberg TNI FRX POV

   Reuters   USD/DJ    Thomson   P/1066 or P/1074 

(Nick Hastings has covered the foreign exchange markets and industry for over 20 years. Apart from his written commentary and analysis, he also appears on Fox Business News and CNBC television in Europe, Asia and the U.S. He can be contacted on +44-20-7842-9493 begin_of_the_skype_highlighting              +44-20-7842-9493      end_of_the_skype_highlighting or by email: nick.hastings@dowjones.com)