Why May Should 'Win Big' and Implications for British Pound v Euro and US Dollar
- Market quotes (8-6-17):
- Pound to Euro exchange rate: 1 GBP = 1.1506 EUR
- Pound to Dollar exchange rate: 1 GBP = 1.2953 USD
Foreign exchange markets and analysts are quietly confident in the Conservative Party recording a decent win on June 8, and are therefore happy to discount the threat of a hung parliament.
As Britain goes to the polls we are seeing Sterling hold recent levels bouyed by the final opinion polls that give the Conservatives an advantage that should see the Conservatives extend their Parliamentary majority.
Foreign exchange markets appear to be quite sanguine about the recent narrowing seen in the polls with the Pound holding familiar territory against the US Dollar and rejecting fresh 2017 lows against the Euro.
In short, the message is that those polls that warned that the Conservatives might lose their majority in Parliament are wrong.
“We think the opinion polls overstate the recent surge in support for Labour,” says Daniel Vernazza, Chief UK Economist at UniCredit Bank.
The trend in the polls since the calling of the General Election has been clear - one that favours the Labour party which has dramatically closed the gap on the Conservatives in opinion polling.
This creates a level of uncertainty for financial markets which have to now contemplate the potential for an unstable coalition or minority government.
Currencies loath uncertainty so it is little wonder such an outcome is negative for Sterling.
Despite this narrowing we have reported that betting markets have actually cut odds on Theresa May’s chances of winning the vote comfortablywhile the cost of insuring against major currency moves on the foreign exchange options markets has also fallen.
Latest polling from Lord Ashcroft suggests the Conservatives should win a majority of 64 while Electoral Calculus sees the majority at 72, a floor that has been in place for some time now.
Rally in Sterling on Big Conservative Win
UniCredit are forecasting a rally in Pound Sterling should the Conservatives win big.
Others agree with this stance.
“We expect the Conservative Party to have a overwhelming victory, which may underpin GBP despite rising volatility, say CitiFX in a brief to clients. “Whether the Conservative Party can expand its advantage is significant for Brexit procedure. Markets are focusing on this election. GBP volatility may increase in the short term.”
Polls are tight but UniCredit have set out six reasons as to why they expect the Conservative party to increase their majority:
1) Historically the approval rating of the leader has proved to be a very good predictor of election results. One pollster, Ipsos Mori, started polling on leadership approval as far back as 1979 and in every general election since then the party with the most popular leader won.
Theresa May, in contrast, has a high approval rating and, while it will concern the Conservatives that her rating has fallen steeply in recent weeks, it is still significantly higher than that of Jeremy Corbyn.
2) Jeremy Corbyn has moved the Labour party further to the left-wing of politics. For example, the party manifesto includes plans for the nationalization of energy companies, railways, buses and the Royal Mail. Previous elections where Labour shifted strongly to the left, notably Michael Foot in 1983 and, to a lesser extent, Ed Miliband in 2010, resulted in big defeats.
3) UKIP’s job is done meaning the party’s 12.6% of the vote share garnered in 2015 is potentially up for grabs. The extent to which those lost votes go to the Conservatives will matter.
“There’s no doubt that the vast majority of ex-UKIP voters are going to the Conservatives,” says Matthew Goodwin, professor of politics at Kent University. “Between 40 and 60 percent of ex-UKIP voters are going to the Conservatives. The highest number we’ve seen going to Labour was 20 percent.”
4) The Labour Party performed poorly in local elections and lost seats in Brexit-voting Labour heartlands. This tells us something that polls cannot.
5) The UK economy remains resilient and grows at a steady pace. Governments are often voted out when the economy is performing poorly.
6) The Liberal Democrats have failed to capitalise on their pro-EU stance. The party was hoping to hoover up the support of many remain voters.
Risks to the Call
UniCredit admit there are risks to their call.
One of these is that Theresa May’s decline in personal ratings are on a terminal path. It’s hard to tell how May has weathered the London Bridge terrorist attack.
While some have seen a positive performance it has opened up questions about her overseeing cuts to the numbers of police officers while at the Home Office.
Above: How has Theresa May's oversight of police budgets while at the Home Office impacted her chances of winning on June 8?
A second risk is that young voters turn out in large numbers. The younger vote is notoriously less-assured than the pensioner vote which presents the Conservatives with an advantage.
A total of 1.05 million 18-24 year olds since Theresa May called the snap general election on 18 April.
"Younger voters are much more likely to vote Labour than Conservative, but they are also much less likely to turnout to vote. Therefore, turnout will be key in this election and, if high, it might suggest Theresa’s May’s gamble has not paid off,” says Vernazza.
What Will the British Pound do on a Strong Conservative Win?
So the base-case is a Conservative win big, how will the currency move in the wake of such an outcome?
UniCredit say a larger Conservative majority will reduce near-term political uncertainty.
“We would expect the immediate reaction to be a rally in sterling. Cable may well break back above the 1.30 level, while EUR-GBP could slip temporarily towards its April/May lows in the 0.85 area,” says Vernazza.
EUR/GBP at 0.85 equates to a Pound to Euro exchange rate of 1.1765.
By comparison, Citi are forecasting the Conservatives to win at least 109 seats, with 190 seats being the upside limit.
On the back of such an outcome, “GBP/USD may rise to 1.3048, with support at 1.2769,” say Citi.
But Strength Won’t Last
UniCredit have made it known for some time now that they are bearish on Sterling’s prospects going forward and they maintain this long-term view, particularly against the Euro.
“While the currency could remain resilient against the USD, helped by the weak dollar factor, we maintain our medium-term bullish view on EUR-GBP,” says Vernazza.
This negative view on Sterling and positivity on the Euro is based on 1. strong sentiment for the Euro (absent a dovish ECB surprise) and 2. reversal of net capital flows into the UK, which supported GBP in the past, as the slowdown of the UK economy will likely go beyond what markets currently expect and Brexit negotiations will likely be very difficult.
UniCredit remain EUR/GBP bullish, with a forecast of 0.89 for end-2017, this corresponds to a Pound to Euro exchange rate at 1.1236.
