Sterling fell against both the dollar and the euro on Friday, hurt by the anti-EU UK Independence Party winning a seat in parliament for the first time, which underlined the risks for both main parties ahead of a national election next year. Against a trade-weighted basket of currencies, it fell to a three-week low, with investors also growing wary of the pound amid more signs of growth in Britain moderating. That is likely to push back expectations of an interest rate hike in the coming months, making the pound less attractive.
Data released on Friday showed British construction fell sharply in August, hit by a fall in house-building. Britain's trade deficit narrowed in August but only because imports fell more sharply than exports, boding ill for the economy. Sterling was down 0.5 percent at $1.6035 against the dollar while it was down against the euro, too. The single currency was up 0.15 percent at 78.84 pence.
"Tactically, we expect sterling to drop against the dollar," said Thierry Wizman, global interest rate and currencies strategist at Macquarie. "We expect the market to slowly push back chances of a rate hike in the UK. The Bank of England could even raise rates after the Federal Reserve."
Currently, investors are pricing in a chance of a rate hike by the BoE in the spring of 2015, ahead of the Fed which is not expected to tighten policy until the second half. But flagging growth in the euro zone, Britain's biggest trading partner, could spill over and hurt economic activity. The pound had surged more than 15 percent against the dollar in the year to mid-July on expectations the BoE would raise interest rates before its peers in the United States and Europe.
But it has fallen almost 7 percent in the three months since then as the expectation of a rate hike by the end of 2014 faded. Uncertainty in the lead up to the Scottish independence referendum that was held in mid-September also drove speculators to place bets against the pound. The latest results from the by-elections have also soured the sentiment towards the pound, traders said. It has raised the threat that UKIP could pose to the ruling Conservatives and the opposition Labour Party ahead of next year's election.
"The pound has taken a bit more of a hit than some of the others and the political situation is definitely on people's minds," said one foreign exchange dealer with an international bank in London. "I think people are aware in general that it is a protest vote, but it is certainly raising questions about how the election will go next year." A swing to UKIP from Prime Minister David Cameron's Conservatives gave the party almost 60 percent of votes in Thursday's by-election in Clacton on Sea, north-east of London.
The party, which wants Britain to withdraw from the EU and impose strict curbs on immigration, also came a close second in a second vote in the north of the country. With eyes on the different fiscal promises made by Cameron and the left-leaning Labour party, financial investors are likely to prefer another Conservative administration. But a victory for the Conservatives also raises the prospect that Britain could vote to leave the European Union in a referendum Cameron has promised by 2017 if reelected.