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The Pound Fears Another General Election, Which May Might Have Just Hastened

10 Downing Street

Image © Gov.uk

- Pound above key levels against Euro and Dollar on May's overture to Corbyn

- But May faces fierce Conservative Party backlash

- We expect Sterling strength to be capped around nearby highs

Pound Sterling entered the mid-week trading session stronger with markets responding positively to news the UK's Conservative government will engage the main opposition Labour Party in order to try and establish a Brexit deal that can be ratified by a majority in the House of Commons.

However, we believe gains in the currency are capped - and downside risks are growing - as the move by Prime Minister Theresa May has drawn fierce criticism from colleagues in her party, raising the spectre of defections which could leave the government without a majority with which to govern.

It is speculated that any Conservative-Labour deal would likely include some form of committment to a customs union between the EU and UK, as this has long been the price demanded by Labour Party for their support.

"I am offering to sit down with the leader of the opposition and to try to agree a plan - that we would both stick to - to ensure that we leave the European Union and that we do so with a deal," May said inside Downing Street on Tuesday, April 03. "We will need a further extension of Article 50, one that is as short as possible and which ends when we pass a deal. We need to be clear what such an extension is for - to ensure we leave in a timely and orderly way."

Corbyn said he would be "very happy" to meet May and that he would set no limits ahead of the talks, while reiterating that his party aimed to keep a customs union with the EU, access for Britain to its single market and protections for workers.

The Pound was rewarded by a market that sees value in ties between the EU and UK being as tight as possible following Brexit.

"PM May calls for a unified government approach to unlock the Brexit jam," says Gregg Gibbs at Amplifying Global FX Capital, "this appears to offer a way to find a timely agreement that would allow Brexit to take place on 22 May; a result that should support the GBP."

The Pound has rallied into the mid-week session on the news, with the Pound-to-Euro exchange rate trading above the psychologically key 1.17 level and the Pound-to-Dollar exchange rate going back above the 1.31 level.

While the news appears to be positive for Sterling we caution that the political waters might in fact have become a little murkier and we are wary of the implications this might have for Sterling over coming weeks.

By reaching out to the Labour Party and pivoting towards a softer Brexit May risks alienating herself from the Conservative party core, which could well mean she is unable to govern.

Signs of displeasure are growing, with the resignation on Wednesday of Nigel Adams, the Member of Parliament for Selby & Ainsty and the UK Government Minister for Wales.

"Following yesterday’s cabinet, this morning I’ve been to Downing Street & resigned my position as UK Government Minister for Wales & Government Whip. I’m grateful to the PM for the opportunity to serve as a Minister since 2017 & will continue to serve my constituents from the backbenches," says Adams.

It is worth remembering those left serving in government can largely be considered as being moderates with the more staunch 'Brexiteers' and 'Remainers' having already quit. May simply cannot afford to alienate the moderate contingent of the party. 

The response by a swathe of Conservative party members has been notably negative; with disquiet being expressed through the party structure, right from the 'big beasts' to prospective local councillors.

This leads us to believe May has only hastened the onset of a general election by proposing to form a cross-party Brexit deal, and this is a big negative for the British Pound.

"We turned Negative GBP recently due to markets not pricing the risk of a Corbyn government adequately in our view," says Thanos Papasavvas, Founder & CIO of ABP Invest. "The population is getting fed up with the Tories' constant internal crises and their inability to form policy."

European Research Group chairman Jacob Rees-Mogg has described Prime Minister Theresa May's plan to extend Article 50 and hold talks with Labour leader Jeremy Corbyn as "deeply unsatisfactory."

Boris Johnson, former Foreign Secretary and potential Conservative leadership contender says, "the PM and cabinet have concluded that any deal is better than no deal, and this is truly a very bad deal indeed - one that leaves us being run by the EU. I can under no circumstances vote for a deal involving a customs union as I believe that does not deliver on the referendum."

We wonder if parliament is unable to pass any new cross-party Brexit deal thanks to an overwhelming opposition by the Conservative party.

"I am genuinely stunned at PMs statement. There were options. This is the wrong one, in my opinion," says Craig Tracey, Conservative Member of Parliament for North Warwickshire & Bedworth.

And, the opposition runs right down through the party structures.

"Speaking as an officIal Conservative Party candidate in the upcoming local elections, that speech by May is equal to political suicide. She needs to go ASAP," says Hani Mustafa, a prospective Conservative Party Councillor in Peterborough.

"Corbyn could refuse to offer a compromise acceptable to moderate Conservatives and/or insist on a confirmatory referendum in the hope of fracturing the Conservative party and trigger a snap election. We thus raise the risk of a Corbyn-led government to 20% from 15%," says Kallum Pickering, Senior Economist at Berenberg Bank in London.

So while news on the Brexit deal front might have improved for the currency, the political environment appears to have deteriorated. We would expect gains in Sterling to be capped as a result.

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