Sterling will not buckle just because the government is weak

What's the big deal? The rule of thumb economists call purchasing power parity has suggested for years that $1.60 is approximately the "right" level for sterling. So $1.50 is hardly a wacky exchange rate, especially when you remember that $1.38 was seen during the banking bailouts a year ago. The real madness was the $2 mark seen as recently as the summer of 2008. None of which is to deny that markets may continue to react with alarm to the prospect of a hung parliament, which was the main factor behind today's big fall. How low could the pound go? Well, $1.30 against the dollar and parity against the euro are plausible if the market's worst fear materialises: a coalition government. What would happen then, though? The most likely plot is surely the one in which a formation of a new government in the UK – any government – prompts a reappraisal of the facts. In theory, even a coalition government ought to be capable of making decisions on spending cuts, especially if the gilt market makes it clear that inaction would be financially painful. History – apart from a brief period in the mid-80s – suggests $1.30 is when you should buy pounds. It's not as if the US is a debt-free zone where political harmony reigns.