A Corbyn Victory and the British Pound: Some Views

Theresa May's grip on power looked to be slipping following the October Conservative Party conference - this matters for the Pound which won't like May's potential Labour successor.

Odds on Jeremy Corbyn becoming the next Prime Minister of the UK spiked to 4/1 in early October as punters sniffed the vulnerability of the incumbent Theresa May following a thwarted attempt by MPs to convince her to stand down following a less-than-stellar Conservative Party conference address.

Meanwhile, various opinion polls put the Labour Party ahead of the ruling Conservative Party by up to 2% confirming the opposition's meteoric rise from apparent no-hopers at the turn of the year.

Markets are therefore seriously considering the impact on the economy - and the Pound - of Corbyn taking the reins of power.

Initial assesments from the currency analyst community show heightened risks Sterling would depreciate if Labour got into power because of the potential for further turmoil around Brexit talks, and investor concerns over Labour's extensive renationalisation programme.

"Not only would investors baulk at Corbyn’s plan to re-nationalise railways, water and energy but Brexit negotiations would likely be thrown into further turmoil on a change in government. This suggests that the downside risks to GBP are substantial if an election is announced," says Rabobank's Senior FX Strategist, Jane Foley.

A Tenuous Grip on Power

The possibility of a general election in the not too distance future is not as unlikely as it seems.

Whilst most senior tories rallied around their leader at the weekend following her disastrous conference speech, an active minority of backbenchers remain critical.

Most recently the PM has come under fire from Eurosceptics within her party after she suggested the European Court of Justice (ECJ) would continue to have jurisdiction in the Uk after the deadline for Brexit during any transition period agreed.

If May's position became untenable and she was to resign it could "set in motion a chain of events which could lead to a fresh election," says Rabobank's Foley.

According to recent polls Labour would then have a shot at winning as Jeremy Corbyn is the joint favourite with foreign secretary Boris Johnson to be next Prime Minister of the UK.

"The implication is that investors have to prepare not only for Brexit but also for a possible lurch to the left," says Foley.

This suggests further downside risks for Sterling in the short-term as well.

Political uncertainty is now such a potent mover of markets it trumps central bank policy.

"When political uncertainty is layered on top of fear that the UK economy is slowing, downside risks for the pound grow stronger almost irrespective of the BoE’s threat to hike interest rates as soon as next month," says Foley.

The latest opinion poll published by YouGov from October 4-5 which was just after may's conference speech debacle indicates Labour might win the next election, after it showed Labour on 42% and the Conservatives on 40%.

Weighing on the Pound

Rabobank believe the prospect of a Labour government add another layer of uncertainty over Sterling and partly justifes their forecast for the EUR/GBP exchange rate to rise up to 0.95 in 12 months.

This gives target on the GBP/EUR exchange rate of 1.05.

Analyst Hans Redeker with Morgan Stanley is also betting on the Pound to remain under pressure as long as the prospect of General Elections and a potential Labour victory remains real saying the chance of Labour victory, “would put GBP under immediate selling pressure.”

“The Labour Party’s agenda suggesting higher taxes on corporates and high income earners may weaken investment further, and may even lead to substantial capital outflows. GBP-denominated assets including housing may find it difficult to rally,” says Redeker.

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Corbyn's Impact on Investor Confidence is Key

Other analysts are more sceptical that labour's plans to increase public spending will lead to a stronger Pound, pointing out higher public spending will lead to more debt and a higher current account deficit as the debt will have to be financed from money sourced abroad.

Whilst that need not necessarily lead to a weaker Pound much depends whether investor's fear of the UK not being able to service its debts overcomes their greed to receive more interest on their capital from the higher rates being offered.

What would then be potentially catastrophic for the Pound would be if investors then lost faith in the government’s ability to pay its debts.

“When that relationship breaks, it breaks in a very extreme manner,” says Société Générale's, FX Strategist Alvin Tann, suggesting a loss of faith in GBP plc could lead to a market crash.

“From a fundamental point of view that (more debt) will be negative for the UK’s external account,” Tann says, and therefore negative for Sterling.

Investors could also be put off by Corbyn's extreme socialist stance - reflected in his desire to nationalise core industries in the private sector.

If Labour are percieved as overly socialist and anti-business foreign investors will be put off which will result in less money flowing in, which will be a negative for the Pound.

"With foreign investment, access to talent and tax burdens already such an unknown quantity in post-referendum Britain, the last thing UK Plc needs now is concern that a wave of nationalisation could sweep away incentives for private enterprise," said Edward Hardy, and economist at World First.

David Davis Please

Interestingly, for Rabobank the best outcome for the Pound would be a David Davis-led conservative government:

"A change in leadership in the UK government would clearly worsen the chances of progress in the talks, although a Davis-led Tory government could be less negative than any other permutation given that he is already chief Brexit negotiator," said Foley.

Corbyn Wouldn't be that Bad

However, other analysts are not so pessimistic.

Jordan Rochester at Nomura sees the possibility of upside for the Pound in the event of a Corbyn win.

Less austere fiscal policies and a probably 'softer' Brexit stance seem to be the main reasons.

"So once the knee-jerk reaction lower in GBP takes place, the expectation of tighter BoE policy would see an improvement in real yields and the fall in GBP to eventually be offset. GBP would also benefit from Labour’s stance on Brexit being somewhat “softer” than the Conservatives, especially if it forms a coalition with the SNP and Liberal Democrats," said Rochester.

JP Morgan's currency team takes a similar view saying a possible hung parliament — if the Conservatives failed to secure a majority — could end up as a positive for the Pound.

"In the post-referendum world, all political developments need to be viewed through a Brexit prism and an argument can be made that a hung parliament which delivered or held out the prospect of a softer-Brexit coalition of the left-of-centre parties (Labour/Lib Dems/SNP) might actually be GBP positive," the bank writes.