Sterling traders are poised for potential drama this week as the results of the UK’s general election will confirm on Friday whether the recent strong gains in the currency are justified, or heading for a nasty unravelling.
The pound has muscled 8 per cent higher against the dollar since early October, pushing above $1.31 as opinion polls have consistently showed a clear Conservative lead in the final week before the vote. The currency has also made similar gains against the euro and surged to its strongest since May 2017 against both its peers.
A clear Conservative majority would “set the stage for a likely swift Brexit resolution early next year as well as more expansionary fiscal policy”, said Zach Pandl, a currency analyst at Goldman Sachs.
Measures of expectations for large price swings in the pound in the next four weeks climbed on Monday, as traders braced themselves for the results of the December 12 election, which will trickle in through Thursday night and early on Friday. If the Conservative party ekes out a majority win, the pound could see further gains, but other outcomes could prove punishing for the currency by opening up yet more uncertainty around the next steps in Brexit.
Michael Metcalfe, head of global macro strategy at State Street Global Markets, said the pick-up in the pound in recent weeks was a “puzzle”. The only way to explain it, he said was that markets were brushing off the vote shocks from the referendum and 2017 general election, and showing “unencumbered confidence in the polls, as well as what will happen after”.
This could easily prove faulty, he suggested, as investors were anticipating “a lot of certainty into what could still be very uncertain times”.
If the results are consistent with opinion polls, the pound could strengthen to $1.35 and €1.21, Goldman Sachs said, indicating about 2 per cent gains. Barclays analysts also expect the currency to notch up immediate gains of up to 1.5 per cent if there is a clear Conservative majority, but said that if voting results did not show a decisive win by 3am on Friday, a hung parliament would become a likely outcome.
“A hung parliament or Labour majority . . . would catch markets completely by surprise,” the UK bank said in a note.
A hung parliament would be likely to weaken the currency to below $1.27 while a Labour majority could whack the pound to trade as low as $1.25, Barclays said. Prime Minister Boris Johnson has promised that if his Conservative party wins, the UK would leave the EU with an “oven-ready deal” on January 31.
Volatility would also be likely to pick up meaningfully, as the next steps on the Brexit process would become less certain. On Monday, the measure of expected price swings in the pound over the next month was more than double that of other big currencies like the euro, and higher than some emerging markets currencies like the Mexican peso.
“Punters have the odds of a Labour majority as a 20 to 1 bet, nothing the market should be too concerned about,” said Sebastien Galy, a macro strategist at Nordea Asset Management.