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British Pound Tears Higher as May Seeks to Sideline Hard-Brexiteers with General Election Call

Traders and the markets

  • Pound to Euro exchange rate: 1.1918, day's high: 1.1937, low: 1.1746
  • Pound to Dollar exchange rate: 1.2756, day's high: 1.2768, low: 1.2514

Pound Sterling was easily the best performing major currency on the day British Prime Minister Theresa May called a snap election for June 8.

The announcement was unexpected in that May has repeatedly said she was not looking to make such a move despite her party's commanding lead in the polls.

But, it would appear the Government believes a commanding victory in June would strengthen the UK's hand in Brexit negotiations.

“The markets were quick to price in greater economic and policy stability under what they expect will be a significant majority given the weakness of the opposition," says Peter Ashton, Managing Director at Eiger FX.

May says the election needs to done before the EU agrees its negotiating position.

"The negotiations with the European Union will reach their most difficult stage in the run up to the next general election," said May in an announcement made outside Downing Street. "We need a general election, and we need one now."

"Overall, today’s announcement suggests that PM wants full control of the Brexit process without any interference from the opposition," says Shilen Shah, Bond Strategist at Investec Wealth & Investment.

If the elections grant the Conservative Party greater support, this could put the UK in a stronger position to negotiate Brexit, "which could strengthen the Pound,” notes Alexandra Russell-Oliver at Caxton FX.

May Seeks to Sideline 'Hard-Brexiteers'

However, it appears markets are looking at a Conservative landslide from another angle.

There is the suggestion that a win for the Conservative Party would lessen May's reliance on Brexit hardliners within her own party and leave to a more 'constructive' Brexit.

"The markets may also be encouraged that Mrs May will now be able to follow a pragmatic middle path towards Brexit, without sabotage either from other parties or from hardliners within her own," says Jonathan Loynes, an analyst with Capital Economics.

Mike Amey at Pimco says a more commanding Conservatives majority would "give the government more room for manoeuvre during the Brexit negotiations, and make the government less exposed to the more right wing factions within the party."

In agreement is Luke Bartholomew, investment manager at Aberdeen Asset Management: "The election should hand Theresa May a much bigger mandate to stand up to the harder line, anti-EU backbenchers which currently hold a disproportionate sway over her party’s stance on Brexit. That would be welcomed by financial markets."

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But, the Pound Could Yet Weaken

At present polls show the Labour party to be 21 points behind the Conservative party which would suggest May has a good chance of securing a commanding majority.

The Labour leader Jeremy Corbyn has since confirmed his party will back a bill placed before parliament on Wednesday 19 April legislating for the vote.

However, we should not forget that the UK now enters a fresh period of uncertainty, and markets hate uncertainty.

"Today’s announcement of a snap General Election comes with a big warning sign and investors shouldn’t forget the negatives – namely that the election prolongs UK political uncertainty, which has undoubtedly been GBP’s Achilles heel for over a year now. We reiterate that a domestic election will take us no closer to understanding the UK’s future trade and investment relationship with the EU – which in our view will be the primary driver for GBP’s long-run outlook," says Viraj Patel, an analyst with ING Bank N.V in London.

In agreement is Jonathan Loynes at Capital Economics who says none of this means that the pound has now embarked on a sustained ascent.

"Aside from the many other sources of Brexit-related uncertainty, we still expect interest rate differentials to work against the currency in the coming months as the Fed raises interest rates more quickly than the markets expect," says Loynes in a note to clients.

Ahead of May's announcement Pound Sterling was seen as the best-performing major currency as traders returned to their desks following the easter break amidst elevated geopolitical risks.

We saw last week that the Pound enjoys periods of market nervousness with the currency jumping in the wake of escalating tensions between the United States and Russia and the United States and North Korea.

“Sterling is an outperformer when geopolitical risks are high. Sterling may find support this week, given it has tended to appreciate in times of increasing geopolitical risk and exhibits positive seasonality during April,” says Hamish Pepper at Barclays in London.

Pound Gains on IMF Upgrade + Market Nerves

There were other reasons to be buying Pounds on April 18.

The IMF has said the UK economy would grow by 2% in 2017 – making it the second fastest-growing advanced economy after the US.

The Fund noted in its latest World Economic Outlook publication that growth had “remained solid in the United Kingdom, where spending proved resilient in the aftermath of the June 2016 referendum.

Sterling was however strong even before the May and IMF announcements with the currency gaining as global stock markets and commodities were sold off.

"According to our analysis of geopolitical risks in the Overview section, GBP is among the outperformers," says Hamish Pepper, an analyst at Barclays who believes the Pound should perform better than its rivals at times of market stresses.  

After a long weekend, where many markets outside the US were closed, geopolitical tensions regarding Syria and North Korea and concerns about the French presidential election continue to weigh on risk sentiment.

Safe-haven assets including the Yen and gold appreciated sharply, while US Treasury yields declined.

The FTSE 100 is one of the worst performers, led lower by materials and energy prices.

Indeed, the materials - or commodities - sector is catching attention today.

“This is a reaction to the sharp drop in iron ore prices, which are now at their lowest level since November. It’s a supply/ demand problem; with too much iron ore getting produced and Chinese demand for steel slowing. While I have no empirical data to back this up, could weaker Chinese demand for steel suggest that growth in the Asian powerhouse has peaked?” says Kathleen Brooks at City Index.

“If I am correct, then strong Q1 data, China’s GDP rose by 6.9% YoY, beating estimates of 6.8%, boosted by strong retail sales and industrial production, could be the swan song before things turn ugly later in the year,” says Brooks.

Of course, iron ore demand is just one measure of Chinese growth, but Asian equities were spooked, the Hang Seng fell 1.35% on Tuesday.

The Australian Dollar is under notable pressure this morning and Barclays cite the currency as one of the most at risk of negative market conditions.

It is for this reason that GBP/AUD is a buy this week with strategists at the investment bank.

Pound’s Focus to Shift onto Retail Sales Towards End of Week

The focus is going to shift to UK retail sales on Friday.

Retail sales represent about a fifth of UK consumption and their contribution to the first quarter is likely to be negative, unless the print is above 3.1% m/m (a peak beyond the range of the past five years).

“This is likely the consensus, as is the fact that the print is typically volatile and prone to revisions. In our view, a negative print that is not too extreme could support a modest rebound in GBP,” says Pepper.

“A negative performance in retail sales has only a limited value to predict consumption, and a print broadly in line with our forecast would not change our view that inflation-driven increases in BoE tightening may support Sterling over the next months,” says Pepper.

 

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