Pound Sterling Could Fall 3.5% on Hung Parliament say SEB

• Foreign Exchange Market quotes (8-6-17):
• Pound to Euro exchange rate: 1 GBP = 1.1506 EUR
• Pound to Dollar exchange rate: 1 GBP = 1.2952 USD

Strategist Richard Falkenhall at SEB warns he sees the British Pound falling sharply if the Conservative party fail to secure a good majority in the upcoming General Election.

This finding is in common with those of the majority of foreign exchange specialists we follow but expect the scale and scenarios to differ slightly depending on the analyst.

What is important for those with an interest in the foreign exchange market at the present time is to gain an educated sense of scale and directionality, rather than obsess over the exact targets.

Analysts are wary of a number of possible electoral outcomes and have this set out a number of scenarios that could play out on the foreign exchange markets.

After all, the Brexit vote and 2015 election were not called accurately by the polls.

“Therefore, although the result this time around might seem fairly certain it may still be worthwhile to consider potential reactions to different outcomes,” says Falkenhall.

Three Scenarios for the Pound

1) Conservative Party majority:

This is easily the most expected outcome and is likely mostly discounted in current market prices. We have seen Sterling move higher through the week thus far with betting markets cutting odds on a May majority while movements in the futures market also confirm this to be underway in FX.

Immediately we would understand that there would be a downward correction on any other result than a Conservative majority.

“We believe such a result would cause the pound to strengthen mainly because the risk of a different outcome has been eliminated,” says Falkenhall.

In 2015 the GBP appreciated by just over 1% after exit polls showed a lead for the Conservative party, which later was confirmed.

SEB forecast Sterling to gain around 1% if the Tories win a majority.

2) Labour Party majority:

Given current polls this would be by far the biggest surprise to markets and would command a counter-move to that witnessed in the run-up to the vote.

“In view of the Labour leader’s supposedly low popularity and socialist oriented programme with higher income and corporate taxes, we expect the GBP initially to weaken significantly if this is the result of the election. In this case we estimate Sterling will depreciate by 5%,” says Falkenhall.

3) Hung Parliament:

A more likely outcome than a Labour majority would be a hung parliament where the Conservative party receives most seats in Parliament but loses its overall majority.

Reports suggest civil servants are already preparing for such an outcome.

Although this probably would be less of a surprise than a Labour majority it would nonetheless cause a fairly large initial, negative reaction in the GBP.

“Given such an outcome we expect the currency to fall by 3.5%, to reflect the vast political uncertainty likely before parties devise a workable solution to govern the country. The market’s subsequent reaction,” says Falkenhall.

BUT - Longer-Term, the Conservatives are Seen as Bad for the Pound

So that is how the Pound might react to the election results, but what about longer-term.

This is where it gets interesting as Falkenhall reckons that the Conservative party would be broadly negative for the Pound owing to their approach to Brexit.

“While we believe that any outcome but a Tory majority would weaken the GBP initially, it might in fact be the other way around over the longer term,” says Falkenhall.

An outcome that would soften the tough stance of the Conservative party in the upcoming negotiations with EU will improve chances of reaching a deal and should reduce the ‘hard Brexit’ premium on the GBP.

“We see the prospects of a softer Brexit and fiscal stimulus outweighing the impact of policies such as rises to corporation tax rates. We do not see SNP influence as necessarily leading to a second Scottish independence referendum,” says Oliver Harvey at Deutsche Bank.

Deutsche Bank agree with SEB in that a coalition of left-wing parties would be positive for the Pound insomuch as they would likely lead to a softer Brexit.

We don’t agree with their view on the SNP, and we do have concerns of the longer-term impact on the economy of the inevitable higher taxation and higher debt that such a coalition would invariably deliver.

Nevertheless, foreign exchange is a tricky customer and these views must be seriously considered.

Consensus Predictions for Sterling-Dollar

A poll of foreign exchange analysts conducted by Bloomberg shows that a hung parliament could see GBP/USD fall to 1.2350.

A large Conservative majority would see a rise to 1.31 while a small Conservative majority would see gains limited to 1.3025.

A Labour win on the other hand would see the exchange rate fall down to 1.2484.

The survey covered ABN Amro, BNY Mellon, CBA, CIBC, Mizuho Bank, MUFG, Nomura, Rabobank, Royal Bank of Canada, Saxo Bank and SEB.