James Bevan: Election outcomes and the pound
0Unfortunately both a positive and negative outcome for GBP remain non-negligible probabilities as Britain awaits a result from the General Election. We have discussed probabilities of outcomes and possible scenarios with FX specialists and conclude with the following comments:
1) Clear Conservative win, or Conservative/LibDem/DUP coalition: c45-50% probability
Initial 2% rally in GBP, but selling begins if $1.55-1.56 is reached
- Markets would likely be relieved if more uncertain scenarios and lengthy coalition negotiations have been avoided. Gilt and equity markets may take it particularly positively, with a knock on impact on the currency.
- However, if GBP/USD rises back to 1.55-1.56 on such an outcome, we could see selling of the pound given that ultimately a relatively tighter fiscal stance under the Conservatives should lead to looser BoE expectations, which would be negative for GBP.
- The EU referendum is another problematic issue. Latest polls show rising support for continued EU membership, which could lead the market to ignore this concern all together – but for now we can be cautious that this uncertainty may potentially weigh on business investment and FDI inflows.
2) Labour + LibDem/DUP: c15-20% probability
Initial negative reaction possible for the pound, based on perceptions that Labour are less business friendly and coalition negotiations could take time. However, ultimately there could be a positive outcome for GBP given the prospect of looser fiscal policy, no EU referendum risk and LibDem check on Labour’s business policy. Some analysts expect the net GBP impact to be 1% positive.
3) Labour + SNP hold majority: c20-25% probability
GBP could sell off 2%
We should expect markets to react negatively to this scenario given the perceived business unfriendly bias and potential negative implications for UK unity. Negotiations could also take longer, particularly if Conservatives actually win the single largest share of the votes.
4) No government, new elections: c5% probability
GBP sells off 3% or more
Beyond the election
While the elections will likely drive the near term price action for the pound, there are plenty of concerns for the pound beyond just this risk event.
First, markets are now pricing the first rate hike to be delayed until May 2016 or even September 2016. It looks likely that the Inflation Report on May 13th may validate current market pricing as fair. But continued weak inflation momentum suggests that risk is once again that markets may need to push the timing of policy normalization further away.
Second, signs have emerged that the election may have a negative impact on the economy, which could become more pronounced if no clear outcome emerges. April’s quarterly CBI survey showed an unexpected and large plunge in business confidence, especially relating to intentions to hire or invest.
Third, we are still near the TWI levels where previously Weale and Carney chose to intervene verbally. Export orders in the latest PMI release were particularly hard hit suggesting that competiveness may be suffering. Meanwhile the current account deficit is still wide.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
