The Pound is "a Buy" on any Weakness Relating to Fears of U.K. Government's Collapse

- Pound Sterling is sensitive to political uncertainty once more

- But May's government said to be more secure than many in the market assume

- Nine reasons why the Conservatives will stay united and muddle through their problems

Theresa May Pound exchange rate

© Lee Goddard / Number 10 Downing Street

The British Pound is widely credited as having come under fresh pressure over recent days on the back of doubts of Theresa May's grip at the helm of the Tory party, but wily currency strategists are suggesting any weakness stemming from such fears will be short-lived.

"Any bouts of weakness in the GBP related to fear of a collapse in government are probably buying opportunities," says Greg Gibbs, Founder and Analyst at foreign exchange advisory service Amplifying Global FX Capital Pty Ltd.

Angst over the future of Theresa May's government has once again grown amidst pressure from opposing wings of the Conservative party, each attempting to press the Prime Minister into delivering the kind of Brexit they see fit, with the question of customs union arrangements being the latest focal point.

"The real driver over the short-term is now more related to politics than the economy. The political climate surrounding Brexit has taken a notable turn for the worse after Jacob Rees-Mogg accused the government of “abject weakness” over its backstop Customs Union deal. As the figurehead of a 60-strong pro-Brexit faction in the party, his comments will inevitably increase the speculation that the Hard Brexit faction will try and force a change in leadership," says Derek Halpenny, European Head of Global Markets Research at MUFG.

The Pound hates political uncertainty, and since 2016 uncertainty has been plentiful. Many credit the result of the Brexit referendum with the sharp devaluation in the U.K. currency, but a look at price charts will show Sterling was in decline well before the referendum as traders started to fear a period of uncertainty in U.K. politics.

The result of the referendum ultimately justified the caution thanks to the unexpected result and subsequent turnover at the top of the government sparked by the departure of David Cameron and George Osborne.

Euro to Pound exchange rate chart
Above: The political risk premium in EUR/GBP, i.e. the difference between the actual Euro-to-Pound exchange rate and where traditional fundamental drivers suggest it should be. 

Brexit needs no introduction, but what is key to those watching Sterling is that political risk continues to weigh on the value of the currency based on two uncertainties:

1) What will the nature of the settled relationship between Brussels and London post-Brexit be, and

2) Who will govern the Kingdom

The latter remains a persistent drag on confidence in Sterling with Prime Minister Theresa May being dogged by questions over her tenure in the top job ever since she was exposed by her own apparently ill-judged decision to go to the polls in June 2017.

The issue has grown in prominence over recent days amidst newspaper reports that Conservative MPs are preparing for another snap general election as they fear the Brexit deadlock will become insurmountable for the prime minister.

Sterling "appears to have been undermined by some homegrown U.K. political risk related to an internal Tory government Brexit debate," says Gibbs.

In the wake of the news the Pound-to-Dollar exchange rate has plumbed fresh 2018 lows (granted, Dollar strength certainly can take some of the accolades for this move), but we have certainly noted price action in GBP is taking a cue from domestic political headlines having largely ignored this particular driver over recent months. The Pound-to-Euro exchange rate meanwhile remains caught within a tight range as the Euro itself has resurgent political concerns to consider in the form of a new anti-EU Italian government.

MUFG's Halpenny says a challenge on May might be more palatable to some amidst the fading risks of a Jeremy Corbyn victory, owing to his party's ongoing slippage in the polls.

"If the Hard Brexit camp wish to take a gamble given Corbyn’s receding threat, the time may be now. It will be difficult for the Pound to advance until this political uncertainty recedes," says Halpenny.

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Buy any 'Theresa May Angst' Dips in the Pound

But, for analyst Greg Gibbs at Amplifying Global FX Capital Pty Ltd, any concerns over the future of Theresa May's government are likely to be unfounded and therefore provide an opportunity for currency strategists.

"The more likely scenario is that Tories move forth led by May and find a way forward to negotiate a deal with the EU. As such, any bouts of weakness in the GBP related to fear of a collapse in government are probably buying opportunities," says Gibbs having eyed recent developments.

Gibbs argues "the GBP is still historically cheap, bearing the scars of the Brexit vote; we view it gradually clawing its way back."

Henry Zeffman, Political Reporter at the Times gives a strong and compelling list of reasons why May is more secure than many commentators assume. He points out the following:

1) May herself doesn't want an election to happen, recall she was the chief architect behind the June 2017 election

2) Fixed-term Parliaments Act. "If Mrs May doesn’t want an election then that is basically that," says Zeffman.

3) An election would fundamentally derail the Brexit process

4) "No prime minister will ever call a snap election again" argues Zeffman, observing the stunning turnaround in fortunes suffered by May.

5) A jaded public will balk at going to the polls again

6) Remain-leading Conservative party rebels actually don't want to risk their seats in an election (remainer-in-chief Anna Soubry only has a majority of 863 in Broxtowe).

7) Brexiteers won't risk Brexit, they know the current government offers them the best shot of achieving their hallowed goal of exiting Europe

8) The DUP are reliable partners when it comes to passing legislation

9) The Conservative party's electoral machine is not yet ready to go to the polls

For Sterling, this concern therefore largely looks unfounded.

"We sense an opportunity to buy the GBP brewing on the basis that domestic inflation pressure is building and is likely to bring BoE rate hikes back on the agenda, and home-grown political risk may fade," says Gibbs.

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