Sterling falls in fears over election outcome

The falls came after a recent political poll led traders to fear a Labour-led hung parliament would result from the general election this year, which would fail to adequately cut the UK's spiralling deficit.

The currency fell by more than four cents in a single day last Monday, hitting a 10-month low against the dollar to $1.478 before recovering back above $1.50 later in the week on strong services sector data on Thursday.

Insight Investment's Dale Thomas, who runs the Absolute Insight Currency fund, said FTSE 100 insurer Prudential's decision to bid for the Asian assets of AIG helped spark the dire day for sterling.

"A massive currency trade went through, which looked suspiciously like a corporate transaction – people put things together and assumed it was the Pru," he said.

And the Labour gains in the polls – the Conservatives had been leading for months – dashed hopes for some of a clear Tory election win, Mr Thomas said.

"The market has no confidence in Labour being able to control the deficit sufficiently," he added.

"We are in a situation that can be resolved, but it has got some danger signs."

But Nick Beecroft, a senior foreign exchange consultant at Saxo Bank, reacted last week by hailing "what can justifiably called the beginnings of sterling's collapse".

He said: "Expect a test of $1.40 within a month and, as the global landscape turns ever-more ugly on the back of deflation and sovereign debt concerns, a continuing flight to the US dollar, taking sterling down below $1.20 by the summer," he said.

Saltus multi-asset fund-of-funds manager Dan Kemp said the pound had fallen by 5 per cent against the dollar in just 10 trading days.

"The latest fall in sterling has been accompanied by a sharp jump in government bond yields, as bond holders demand greater compensation for the risk of inflation," he said.

"This reinforces our view the key investment theme for 2010 will be the weakness of safe haven assets such as government bonds, which in turn could create significant volatility in risk asset prices."