GBP: Guided by political permutations - Rabobank

Jane Foley, Senior FX Strategist at Rabobank, suggests that for GBP the UK political backdrop is currently unusually complicated and since price can only move in two directions the markets have a tendency to ascribe binary outcomes to sometimes complicated political and economic events. 

Key Quotes

“For investors trying to reconcile Labour vs. Tory and soft Brexit vs. hard Brexit, GBP could be facing a volatile period dependent on the result of the June 8 election.”

“Since investors tend to be pro-business, typically markets favour liberal, right-wing governments over left wing leaders and pro-globalisation movements over protectionist/nationalist ones. Additionally, the near 10% drop in the value of GBP/USD on the day it was revealed that the UK had voted to leave the EU demonstrates investors’ suspicions of that outcome.  The implication is that markets would favour a ‘soft Brexit’ over a ‘hard’ one.  Indeed, this is how the pound reacted to Brexit related news in the period between last June’s referendum and January 17.  On this date, PM May outlined her Brexit proposals and won support both for her forthright leadership style and for finally outlining a plan – even though she was proposing a hard Brexit.”

“The latest analysis from YouGov suggests that the UK could end up with a weak Conservative government, committed to a hard Brexit.  This is clearly not a welcome scenario for GBP.”

“The latest modelling carried out by YouGov for the Times newspaper suggests that the Conservative party could lose as many as 20 seats following next week’s election.  Even though the results of YouGov’s model are highly variable and also suggest that the Tory’s could gain 15 seats, a clutch of recent opinion polls have been suggesting that Labour have been gaining momentum as the general election nears.”

“In theory Labour’s Brexit stance stance should be welcome for GBP.  However, fears that Labour’s pledge not to ‘distinguish between migrant labour’ could alienate EU governments particularly in Eastern Europe during Brexit negotiations.  Also, uncertainty about UK defence policy under Labour leader Corbyn could unsettle the pound.  Potentially of more immediate concern for the market would be speculation that economic reforms could be unwound under a hard-left Corbyn government and that the budget deficit will bear the brunt.  In our view GBP is unlikely to welcome a success for Labour next week despite the party’s softer position on Brexit.”

“While it is difficult to squeeze the current complexities of UK politics into a binary universe, the behaviour of the pound this year suggest that a relief rally would likely follow a strong victory for May next week, while the pound could fall on any other outcome.  Of course, the clues offered by market reactions in recent months have been coloured by positioning.  We have frequently argued that short-covering squeezes have exaggerated GBP’s reactions this year and that the pound’s apparent endorsement of PM May’s decisions on April 18 was a function of the market holding near-record short positions. While the market is still short sterling, there is evidence that the recent round of position adjustment is over.  This factor combined with a recently improved tone in the USD suggests that GBP/USD1.30 could remain a slippery target for sterling bulls.  Given that the Brexit negotiations are due to start on June 19 and that these are likely to be tough, we would continue to see rallies above the 1.30 level as selling opportunities.  We expect EUR/GBP to edge towards the 0.89/0.90 area by year end.”