Pound Looks to Build on Boris Resignation Jump

Above: Prime Minister Boris Johnson walks back through the No10 door after delivering his statement in Downing Street after resigning as the leader of the Conservative Party. Picture by Andrew Parsons / No 10 Downing Street.

The Pound to Euro exchange rate rose by over a percent on the day Prime Minister Boris Johnson said he would be stepping aside once a new Conservative Party leader has been found.

The gains would suggest the currency had been carrying a degree of political risk premium that looks to have now been covered to a certain extent.

"Starting with the GBP positives, FX markets will be hoping that any new leader would strive to restore party unity and allow the Tories to govern more effectively at a time when a cost of living crisis casts a long shadow over the economy," says Valentin Marinov, Head of FX Strategy at Crédit Agricole.

The Pound rose 1.09% Thursday to quote a high at 1.1840. The pair is at 1.1838 at the time of writing with bank accounts offering rates around 1.150 for Euro payments and payment specialists are quoting 1.18.

Marinov says some of Crédit Agricole's clients are hoping that any new government would adopt a less confrontational stance towards the EU.

Above: GBP/EUR at 25 minute intervals.

Samuel Tombs, Chief UK Economist at Pantheon Macroeconomics, says if a new Conservative leader proves to be more open to striking a deal with the EU over the matter of Northern Ireland it could benefit the UK economy as he expects it to facilitate a recovery in business investment and exports.

But beyond EU relations the direction the UK economy takes will be crucial say economists.

"Some clients further think that any new government would be under pressure by Tory MPs to deliver tax cuts in an attempt to boost growth," says Marinov.

Tombs says the medium-term economic outlook might brighten slightly if a new leader takes greater interest in structural reforms that could increase the economy’s trend growth rate.

Pantheon Macroeconomics calculate trend UK economic growth has slipped from 1.75% in the 2010s to 1.25% at the current time and new reforms to boost labour productivity will be required to push growth rates higher.

The outlook for the Pound is nevertheless challenging, particularly given the U.S. Dollar remains in a strong trend of appreciation.

This would mean GBP/USD is likely to remain subject to downside forces.

The GBP/EUR has nevertheless formed something of a base near 1.15 and is looking to consolidate at higher levels again.

Marinov says a main risk for the UK currency remains a protracted period of political uncertainty linked to the search for a new prime minister and even the prospect of a general election, which could deprive the country of an effective leadership and government at atime of great economic peril.

"While the political risks ahead could force FX investors to heavily discount any of the GBP-positives outlined above, we further note that the BoE has already signalled that the fiscal support pledges announced prior to the latest political upheaval could boost their otherwise gloomy outlook for the economy, with any upgrades likely to be announced at the August policy meeting," says Marinov.

Derek Halpenny, Head of Research for Global Markets at MUFG, says it could be easy to overstate the impact of recent political events on the Pound.

For him, the main Pound exchange rates continue to be dictated to by moves in the Euro and Dollar.

The losses suffered by the Euro against the Dollar over the course of the past week are testament to these significant forces.

"The pound gained yesterday versus the dollar and the euro but versus the rest of G10 the move was more in line underlining the fact that the pound gains were more USD and EUR specific rather than any outperformance related to politics," says Halpenny.

"Tightening financial conditions, risk aversion, falling equity markets have more to run and for a country that recently confirmed is running a record 8.3% of GDP current account deficit, those conditions will dominate GBP performance and continue to undermine performance," he adds.