Pound's Tumble Nearly Done but Politics Loom

The pound's fall is nearly over but foreign exchange markets are still going to watch developments, since parity with the euro can not be ruled out as the country gets closer to a crucial spring election, analysts and traders told CNBC.com Tuesday.

The pound sank sharply against major currencies after opinion polls showed the country's ruling Labour party closing the gap with opposition Conservatives, which could result in a hung parliament.

Sharon Lorimer

Sterling fell to a 10-month low of $1.4781 against the dollar Monday, after having broken through the psychological barrier of $1.50.

"I'm a little bit hesitant to say we'll go lower, the market is so short sterling right now," Alex Edwards, senior corporate dealer at UKForex Limited, told CNBC.com.

Against the euro , the pound also fell, hitting a four-month low Monday.

"Personally, I don't think it falls below that 1.10 figure, just because of the situation in debt markets in Europe," Edwards said.

Many analysts in Britain say that a hung parliament would mean a long-drawn-out, indecisive political process delaying decisions on cutting the gaping budget deficit and the prospect of parity with the European single currency has been raised again.

"That can easily happen," David Karsbøl, chief economist at Saxo Bank, told CNBC.com. "Especially if (UK Prime Minister Gordon) Brown will continue to spend money after the next election."

Mixed Opinion Polls

A ComRes poll in the Independent newspaper showed the Conservatives' lead dropping two percentage points to five points, meaning Labour could still dominate parliament after the election; but a YouGov poll in the Tory-backing Sun showed the Conservatives' lead extended to seven points.

The British may be making their own tragedy, Karsbøl said.

"As a foreigner, I don't think that a hung parliament is that negative," he said, explaining that the two factions would keep each other in check therefore "they would be unable to spend a lot of money."

"If the British become too negative about it, it becomes a self-fulfilling prophecy," he added.

But the prospect of parity with the single European currency is not that close, as markets are still expecting a decision on how to help Greece deal with its massive debt.

"I'd still rather be short (pound versus dollar) than against the euro," Paul Bednarczyk, currency strategist at 4Cast, told CNBC.com.

A solution to the Greek situation is unlikely before March 16, the deadline by which the EU wants the country to come up with a coherent plan to reduce its debt, he added.

Hike Interest Rates

The pound could be boosted by a clear-cut outcome of the election, as the market doesn't really care if it's Labour or the Conservatives, Bednarczyk said, adding: "I don't think the two are very far apart."

The Bank of England could prop up the currency by soaking up excess liquidity it created by buying assets or even by raising rates but it "has no interest" in doing so, he added.

"I don't think they're particularly worried about inflation for the moment," he said.

The central bank has flooded the market with liquidity and the government has poured money into the economy in an attempt to kick-start activity, hard hit by the financial meltdown two years ago.

But stimulus packages only work in the short term and UK's financial sector is "in shambles," which means rates will have to stay low for a long time, Karsbøl said, although he recommends just the opposite medicine.

"I guess the best think the Bank of England could do would be to hike interest rates to get the British people to save more," he said, noting that UK households were heavily indebted, a factor that hinders domestic consumption.

"You'll get a recession in the short term but once you have forced a change in consumers you can move on," Karsbøl added.