Sterling Jumps on UK Poll – More to Come?

Sterling has had one of its strongest days for several years, climbing almost 3% versus the dollar following the release of an exit poll from the UK general election signalling a large majority for the ruling Conservative Party.

Cable jumped to 1.3330 from 1.3170 on the release of the poll, before climbing higher to 1.3510, taking out stops above 1.3450 according to analysts. Consolidation followed, back to 1.3450, but the pair appears to have found a bases there, climbing steadily back to 1.3500 as the first results started coming in and confirmed the exit poll findings. As the Conservative victory was confirmed with the party winning 326 seats – the number needed for an outright majority, Cable was steady at 1.3463.

Although sterling has largely been steady since the initial leap higher, analysts are eyeing further gains for the pair as the results continue to come in. Adam Cole, chief currency strategist at Royal Bank of Canada, says that even if the Conservatives’ majority were to fall a few seats short of projections…the main conclusions going forward would not change and that is that the remaining risk of a relatively hard exit has dissipated.

“So, of course, has the residual risk of Brexit never happening, but in our judgement, the former dominates and GBP has potential to rise further,” he writes in a note to clients. “Had the Conservatives won with a small majority, the leadership would have likely been held to its commitment not to extend the transition period beyond December 2020 by the hard-exit wing of the party. With that group effectively marginalised, there is significantly more scope for flexibility and compromise. Hence, the risk of exiting without a trade deal has fallen.”

Cole adds that RBC’s near-term target is GBP/USD’s gains extending to the high 1.30s, although he does note that Scotland is a “developing risk to watch in the longer-term”, adding, “What currently appears to be an SNP landslide (combined with the certainty that Brexit will happen) will no doubt raise the pressure for another independence referendum, though this is unlikely to be imminent, elections to the Scottish parliament (May 2021) dominating the agenda.”

Neil Wilson, chief market analyst at Markets.com has suggested Cable may target 1.36-1.37, while Thomson Reuters analysts are calling 1.3450 a base for the pair. Elsewhere, Nigel Green, chief executive and founder of deVere Group, says. “Many traders were caught off guard by the size of the majority and this may push the pound even higher than previous predictions. We could see bullish traders now take it to $1.38 or maybe even as high as $1.40. With more political certainty due to the large majority, the UK economy is also likely to receive an election bounce.

“Billions of pounds in business investment that has been on the sidelines due to the parliamentary paralysis is now ready to be unleashed,” he adds. “This will give a much-needed boost the slowing British economy.”

Craig Erlam, senior market analyst at Oanda, observes that the feeling of fatigue is nothing new for those that has followed British politics over the last four years but “there is a sense that we’re finally seeing the light at the end of the Brexit tunnel and that’s what we’re seeing reflected in the pound”. He adds, however, that, “while it is interesting that, while the pound hasn’t continued to march on higher – give it time – it hasn’t really pared gains either”.

Conversely, Tim Graf, head of Macro Strategy for EMEA, State Street Global Markets, feels markets are over-valued, writing in a client note, “Our view is that there is not a lot of upside for sterling left. Our purchasing power parity-based valuation framework puts fair value for sterling against the US dollar at 1.3340 and the euro against sterling at 0.8670. Sterling is now rich versus the other currencies for the first time since the referendum. I can see fair value shifting a bit more in sterling’s favour, as recent strength should have a dampening effect on inflation. In time, that could move those fair values towards 1.36 and 0.84 respectively. But again, we aren’t talking about significant future strength. We are then left with a post-election environment where a harder version of Brexit is possible, perhaps probable.

“Thinking about the way option markets are priced, I do not see a strong case for owning volatility or skew,” he continues. “The collapse in implieds and reversion in risk reversals reflect removal of an event, its attendant uncertainty and what was a very small probability of a sterling-negative Corbyn premiership. However, sterling implied volumes are still amongst the highest in the G10, trading alongside risk bellwethers like the AUDJPY volume. Given the time of year, and so much near-term uncertainty having been reduced with the election and a tentative cooling of US-China trade tensions, sterling cross implied volume will likely not be justified by realised volatility. Finally, with risk reversals back in the middle of the range that has prevailed for most of the last five years, it is hard to argue with the modest downside bias to sterling, in line with our views above.”

In terms of market activity, dealers tell Profit & Loss that traded volume actually went higher after the initial jump to 1.3510, with activity picking up as the pair bounced between 1.3450-1.3500 as results came in and confirmed the exit poll.

Colin Lambert

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