Sterling could rally after British general election

Potentially closer ties with the EU under a Labour cabinet could help the the pound, which has kept the currency in check over the past eight years, strategists say

Sterling has been hit and never fully recovered since Britain voted to leave the EU.

The earlier-than-expected UK election is prompting traders to prepare for the country’s biggest political shakeup since Brexit, despite the mostly muted market reaction since the announcement was made.

Market strategists are gaming out election scenarios, with history showing UK equities trading relatively flat, or lower, during the first six months after wins for the ruling Conservatives. By contrast, stocks have historically strengthened about 6% following victories by the poll-leading Labour Party, according to Citigroup strategists led by Beata Manthey. 

The winner of the July 4 general election will have limited fiscal headroom and face scrutiny from bond vigilantes — as the short stint of Liz Truss as prime minister showed.

British utilities took a beating after the election date announcement, while homebuilders saw a spike in volatility. Defence spending and sale of government stakes could be up for debate, while the status of proposed sale of Royal Mail-owner International Distribution Services could be up in jeopardy.

Elections are often a source of volatility, but political instability since the Brexit referendum has been particularly acute in the UK. Having the general election sooner may help remove this uncertainty, according to Barclays strategists, led by Emmanuel Cau.

In particular, sterling has been hit and never fully recovered since Britain voted to leave the EU. Still, potentially closer ties with the EU under a Labour cabinet could help the the pound, which has kept the currency in check over the past eight years, the strategists said. 

“The potential prospect of a somewhat more stable government may be something of a medium-term positive compared with the political division that’s been prevalent post-Brexit,” Mr Cau’s team said. 

“An unwind of the Brexit premium could lift the pound and favour domestic plays and Ftse 250 over exporters and Ftse 100.”  

Still, the UK stock market is not just swayed by politics and its outlook is heavily dependent on monetary policy as well as the economy. Recent British inflation data disappointed those who were expecting a rate cut from the Bank of England as soon as in June. 

The likelihood of that fell to less than 10% currently, from more than 60% about a week ago, while an August cut has become a coin-flip. That could also be a tailwind for the pound in the near term. 

Bloomberg