Pound braces for impact, regardless of soft or hard Brexit
LAST week’s British election result and the period of political uncertainty that looks set to follow may have come at the worst time for the country’s economy and the value of the pound sterling.
Until last Thursday night in London, Prime Minister Theresa May’s decision to call the snap poll did not look like a pivotal point for the most-sold major currency of last year.
Sterling lost almost a fifth of its value between June 2016, when Britons voted to leave the European Union, and November.
Many had begun to assume that would be the full extent of the “Brexit discount” demanded by overseas investors to keep faith with the world’s fifth-largest economy.
But May’s loss of her majority drove a 2% fall in the pound on Friday and another 1% on Monday, and traders now say the election could prove another turning point for sterling.
After the biggest-ever move in favour of the pound in the four weeks to mid-May, market positioning has reversed.
For many strategists, the election result not only makes the likely shape of Brexit even more uncertain, it also creates a political hiatus that risks the sort of sudden stop to economic activity that many feared would follow last year’s referendum.
“Markets are still trying to work out what the new risk premium is for sterling,” says James Binny, head of currencies at US financial group State Street Global Advisors in London.
“If the Conservatives back a softer Brexit, sterling would seem to want to go up. But if it became much clearer that things were heading downhill from a growth perspective, then that might create a bigger move down.”
Markets now assume May’s failure to secure her party a majority will lead to a softening of the government’s Brexit stance to give greater priority to a close trading relationship with the EU.
But there’s little confidence that the planned loose support agreement with Northern Irish Unionists can keep her minority Conservative government afloat for long, or whether May herself can cling on as premier for the two years of divorce talks.
Anxiety that Britain’s economy may be entering a downward spiral was already growing before the election.
Sterling’s weakness in the wake of the Brexit vote has driven inflation above the Bank of England’s target at a time when household wages and overall growth are not keeping pace, as data on Wednesday underlined.
But high and increasingly static housing costs that eat into the pay packets of young Britons without feeding optimism among their older neighbours mean the Bank of England is forced to ignore rising prices and keep credit conditions ultra-loose.
The combination of high inflation and cheap money then just undermines the pound further.