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Rising General Election Risks to Keep Pound Sterling Under Selling Pressure

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- Snapshot: GBP/EUR: 1.1198 -0.46% | GBP/USD: 1.2681 -0.20%

- Pound under pressure once more

- Prospect of General Election yet another concern for Sterling

- "Uncertainty to keep GBP soft for the near future" - HSBC

Foreign exchange strategists are apparently becoming increasingly weary of the prospects of a General Election taking place before 2019 is out, and this should keep the British Pound under pressure we are told.

Both Ladbrokes and William Hill have cut odds to reflect a 63% chance probability that the date of the next General Election is to be held in 2019 with betting markets eyeing the installation of a New Prime minister who faces the prospect of trying to deliver a Brexit by October 31 with a wafer-thin parliamentary majority.

For Sterling, the prospect of a General Election within six months only adds to chronic political uncertainty in the UK: the Pound shows it dislikes political uncertainty and tends to lose value during election cycles.

The Pound has come under pressure over recent weeks as uncertainty levels rose in response to the failure of Prime Minister Theresa May to pass her Brexit deal, which saw her announce her resignation and fire the gun on a leadership race to find a replacement: the Pound-to-Euro exchange rate has fallen to 1.1240 from highs around 1.17 in early May, while the Pound-to-Dollar exchange rate has fallen down to 1.27 from highs of over 1.31 at the same time.

Foreign exchange strategists at ING Bank N.V. - the Dutch based multinational bank - say of the many potential political scenarios facing Sterling, they attach the highest probability to an early General Election.

The vote could come as soon as December, "which will un-nerve investors," says Chris Turner, Head of FX Strategy at ING in London.

Foreign exchange markets appear to have now fully discounted Boris Johnson becoming the next Prime Minister: betting markets are implying a 85% chance of Johnson taking over the wheel from May, up from 81% last Friday. Meanwhile, a new poll for YouGov shows that should Johnson make it to the second round of the Conservative selection process he will enjoy a comfortable win.

Johnson will face Jeremy Hunt in a final vote to be held amongst Conservative Party members, and the poll shows 77% believe Johnson will make a good leader against 56% who think the same of Hunt.

"Over the next several weeks, the 160k or so members of the Conservative Party will now choose between Johnson and Hunt to succeed May. After the candidate is selected, the real challenge, May's challenge returns. The EC refuses to renegotiate the Withdrawal Bill. There seems to be no agreement in the UK what to do next. Chancellor of the Exchequer Hammond said the only way to break the deadlock may be new elections or a referendum," says Marc Chandler, Chief Market Strategist at Bannockburn Global Forex.

With the markets fully anticipating a Johnson leadership we don't see any big moves in Sterling on his ultimate coronation and believe he is now 'in the price' of the Pound.

Instead markets are looking beyond this and asking whether he can get a Brexit deal through parliament, and if not whether he will have little choice but to try and change the composition of Parliament.

Johnson has stated his favoured strategy to delivering Brexit is to change the Withdrawal Agreement and present something more palatable to the House of Commons, as opposed to pursuing an all-out 'no deal' from the get-go.

However, with the EU suggesting they are not willing to renegotiate, it could be that Johnson has little choice but to opt for a 'no deal' Brexit if he is to live up to his steadfast promise of delivering Brexit before October 31.

This would be a problematic outcome for Sterling, and we would expect another impulse lower in the currency should it become clear this is the route being adopted.

"The risk of another significant change in politics – whether because of a change in Government or a significant shift in UK-EU relations – will likely create enough uncertainty to keep GBP soft for the near future," says Dominic Bunning, a FX strategist with HSBC.

Indeed, parliament has indicated its opposition to a 'no deal' - and a number of Conservative MPs have indicated they will resign should their Government attempt to deliver a 'no deal'. The Government would then likely fall were a no-confidence vote be tabled by the opposition, with ex-Conservative MPs voting with the opposition to topple the Government.

"With parliament overwhelmingly opposed to a no-deal Brexit and little appetite to renegotiate the current withdrawal agreement in Europe, we think a political process – probably elections – will be needed to resolve the way forward," says Hans Redeker, foreign exchange strategist with Morgan Stanley.

Last week senior Conservative MP Dominic Grieve threatened to bring down the Government if it were to pursue a 'no deal' Brexit, and Conservative 'grandee' Ken Clarke has since vowed to bring down any “idiot” future Prime Minister were they to attempt to force a 'no deal' Brexit through Parliament.

We know there are a number of Conservative MPs who have shown themselves to be 'serial rebels' by voting against the Government on Brexit, and we would expect further defections to come from their ranks.

"Regardless of Brexit, any new leader might struggle to command House of Commons support, with the Conservatives still in a minority, and with Brexit having frayed many of the traditional relationships between and within various parties. The new leader might feel the need to push for a clear “mandate”...As such the market might also start to apply a higher probability to an early General Election being called," says HSBC's Bunning.

The threat of a General Election taking place before the 2019 is over has meanwhile prompted ING to cut their forecasts for the Pound. "In this month’s forecast round we are cutting our GBP profile and now see Cable trading to 1.22 and EUR/GBP to 0.92 this autumn," says Turner.

Cable is the colloquial term for the Pound-to-Dollar exchange rate, while a EUR/GBP conversion of 0.92 gives a Pound-to-Euro exchange rate equivalent of 1.0870.

However, it should be evident that there is some time to go before a General Election becomes a real possibility, and markets could opt to adopt a wait-and-see approach over the summer, looking for clues as to how Johnson intends to conquer the most tricky of tasks facing him.

"Politics remain in the driver's seat in Sterling pairings. In our view, markets were pricing in a close to 50% chance of a no-deal Brexit at the end of October when they recently pushed EUR/GBP higher to 0.89. We think this is overdone," says Daniel Trum, CFA, Strategist at UBS. "Our base case is a further extension of the October deadline and eventually General Elections in the UK."

"This should keep the exchange rate in a range around 0.87 over the next 12 months," adds Trum. 0.87 in EUR/GBP translates to 1.15 in GBP/EUR terms.

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