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Pound Sterling Advances on Easing of Political Risks in Wake of Scottish Vote

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  • Market rates at publication: GBP/EUR: 1.1557 | GBP/USD: 1.4044
  • Bank transfer rates: 1.1333 | 1.3750
  • Specialist transfer rates: 1.1476 | 1.3946
  • Get a bank-beating exchange rate quote, here
  • Set an exchange rate alert, here

The British Pound was an outperformer on global foreign exchange markets on Monday May 10 as investors welcomed an easing of UK political risks.

The focus of the weekend was the outcome of the Scottish election, which saw the SNP win the vote but ultimately fail to win an outright majority.

SNP leader Nicola Sturgeon says her party will seek another independence referendum on the basis of an overall pro-independence government it expects to form with the Greens.

But for markets the crucial takeaway is the timing of such a move is unlikely to be soon, given Sturgeon's commitment to seeing through the covid-19 crisis.

The Pound-to-Euro exchange rate rose half a percent to quote at 1.1557, the Pound-to-Dollar exchange rate rose 0.42% to quote at 1.4050.

Pound to Euro May 10

"For EUR/GBP, markets will digest the Scottish Parliament election results, where SNP fell short of winning the absolute majority, but where pro-independence parties did not," says Mikael Olai Milhøj, Chief Analyst at Danske Bank.

"We doubt, however, that another independence referendum will be a theme for long, given it will take a long time before such a referendum would take place, as the Conservative government still rejects it," he adds.

Danske Bank expect EUR/GBP to continue trading around 0.87 (or, GBP/EUR around 1.15).

"That said, we remain overall bullish on GBP," says Milhøj.

Pound to Dollar rate May 10

"The majority of the movement in GBPUSD is dollar weakness but sterling is also flexing its muscles with the Bank of England and local election event risk done and dusted with little cause for concern," says Jeremy Thomson-Cook
Head of FX Strategy at Equals Money.

"The Bank remains cautious as we outlined on Friday and the vote north of the border saw the SNP win Holyrood yet again but without a majority and therefore a wafer-thin mandate for another referendum on Scottish independence," he adds.

The fundamental UK economic picture remains resolutely constructive, which could offer the Pound upside over a multi-month timeframe according to analysts.

"We continue to prefer pro-cyclical currencies, including those under discussion at this week's central bank meetings (i.e., AUD, GBP and NOK) against the yen and the dollar," says Gaétan Peroux, Strategist at UBS.

The Pound appears unable to break out of what are increasingly familiar ranges against some of the more larger G10 currencies with GBP/EUR trading a sideways path between ~1.1470 and ~1.16 since early April.

GBP/USD has since April 20 retreated into an increasingly tight range centred around a mid-point of ~1.3870 and in the near-term swings around here are likely to be faded and mean reversions towards this pivot could be anticipated.

Another pair that highlights this rut in Sterling is the Pound-to-Australian Dollar exchange rate (GBP/AUD) which has encountered weekly changes of +0.18%, +0.03% and -0.16% over the past three weeks.

This is extraordinary stability, but there is a sense that Sterling remains relatively well supported across most pairings.

Ongoing strength in the global economy - and specifically the U.S. economy - leads UBS strategist to anticipate further headwinds for safe havens, a grouping in which analysts typically place the Dollar, Yen and Franc.

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GBP/USD Forecasts 2021

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Provider: Global Reach
Type: Free Download
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Given the British Pound is seen as a pro-cyclical currency by analysts - in that it tends to appreciate when the global economy is expanding - such a global view would underpin the unit.

It's pro-cyclical nature is perhaps best reflected in periods of severe economic shock - such as the Great Financial Crisis and the Covid-19 crisis - which are typically met with severe bouts of Sterling weakness.

The lowest GBP/EUR exchange rate ever recorded did not come in the wake of the Brexit vote, but at the height of the market meltdown of 2008.

Therefore, a supportive global backdrop can be considered to be supportive of Sterling and the consensus amongst analysts is these conditions are likely to persist over coming months.

The global economy continues to recover from Covid-19 and is underpinned by huge stimulus coming from the U.S. and China.

The UK economy is unlikely to miss out on this rebound: the UK suffered one of the deepest declines as the covid-19 crisis forced strict lockdowns, but it is likely to see one of the sharpest recoveries according to economists.

The Bank of England (BoE) holds this assumption and said in the Thursday May 06 policy update they were upgrading 2021 GDP forecasts for the UK economy.

The BoE now projects 2021 GDP growth of 7.25%, compared to 5% in February.

FX transfers: Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more. (Advertisement).

While the BoE said they do not expect to raise interest rates until at least 2023, despite the improved growth outlook, some in the market are more inclined to look through this and anticipate earlier hikes.

Remember, the rule of thumb in FX is that when expectations for central bank interest rate rises come forward, the currency that bank issues tends to rise.

Preceding any interest rate rise is the elimination of quantitative easing and the BoE looks set to complete its current tranche of asset purchases by year-end.

"So long as the economy continues to improve, a further moderate tapering in the pace of bond purchases seems likely at the August announcement. Given that inflation pressures remain muted at this time, we currently do not expect an initial rate increase until the first half of 2023, although an initial hike very late in 2022 cannot be ruled out," says Nick Bennenbroek, International Economist, Wells Fargo Securities.

The BoE now projects 2021 GDP growth of 7.25%, compared to 5% in February, but sees 2022 GDP growth at 5.75%, compared to 7.25% previously.

CPI inflation is forecast by the BoE to rise to at 2.5% in 2021, compared to 2% in February. 2022 inflation is however forecast lower at 2%, compared to 2.25% previously.

It is potentially the latter forecast that convinced markets to shed exposure to Sterling on Thursday May 06, with the currency losing weight against the majority of its peers to succumb to earlier those familiar trading ranges already mentioned.

"The muted response of FX markets to the decision may be due to slightly underwhelming inflation forecasts from the BoE," says Peroux at UBS.

Nevertheless, Wells Fargo look through the near-term market reaction to the BoE May event and tell clients they remain constructive of the Pound.

"By potentially allowing for a slightly quicker path of exit from its accommodative monetary policy stance, we view (Thursday's) announcement as a modest upside risk to our forecast for the pound," says Bennenbroek.

"At the same time, it is also broadly consistent with our medium-term profile which already anticipates modest gains in the pound versus the U.S. dollar over time, and a stronger pound versus the euro," he adds.

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