Chris Towner considers the prospects for sterling.
With the festive season upon us, voting in the general election sits in the middle of our collective Christmas “to-do” list.
The last time the UK held a general election in December was in 1923, and it was an experience that the Conservative Party would rather not repeat. Having won an election the year before, the Conservatives had a comfortable majority and no obligation to go to the public for another four years.
However, the prime minister, Stanley Baldwin, wanted a firmer mandate from the people in order to strengthen his position as party leader. Instead, he lost his majority and ushered in the country’s first Labour prime minister, Ramsay MacDonald, in coalition with the Liberals.
Last Wednesday, YouGov, which accurately predicted the results of the previous general election, estimated that the Conservatives would win with a majority of 68 seats. This forecast gave the pound a significant boost, despite current low volatility in the currency markets.
Sterling’s bouncing back
Overall, in the past few months we have seen sterling bounce back. It’s easy to forget but as recently as August, sterling was trading at 1.0720 against the euro. Now GBP/EUR is trading in the 1.17s, almost 10% higher. GBP/USD has experienced a similar step change and is now challenging 1.30, having had a brief flutter below 1.20 in September.
So, how will this election impact the pound? A win for Labour would certainly give it a fright. The party’s most left-wing manifesto in decades promises nationalisation programmes, significant rises in both corporation and capital gains tax, rent caps for private landlords, and the dilution of large companies’ share capital.
We could expect GBP/EUR to drop back below 1.10 and GBP/USD back towards 1.20, although further downside risks would be limited by the prospect of a softer Brexit. Labour has ruled out leaving the European Union without a deal, saying that they would negotiate a closer relationship with the bloc. They then promise to put the final exit deal to a referendum, with Remain as an option.
On the other hand, a clear majority for the Conservatives would help strengthen sterling further and may loosen the economic restraints caused by Brexit uncertainty.
With a promised fiscal stimulus of £20 billion alongside business-friendly policies (at least in comparison with the Labour manifesto), sterling would be expected to edge back towards 1.40 against the US dollar and 1.2500 against the euro. Then, attention could turn to the trade deal negotiations with the EU, which are ambitiously timetabled to be concluded by the end of 2020.
What would happen if we were to see a repeat of 1923 and a hung Parliament ensued? It would certainly result in further frustration at the continued stalemate in passing a Withdrawal Agreement.
Sterling would likely fall in this scenario by a few per cent with GBP/USD towards 1.2500 and GBP/EUR towards 1.13-1.14.
Looking at the bigger picture, the pound remains undervalued by historical standards, but for understandable reasons. If the fog can lift over Brexit, and trade negotiations with the EU start to gain momentum, then our summer holidays next year should be a little less expensive.
Chris Towner is director at JCRA.