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FX: May lights a fire under sterling, for now

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By:
Farah Khalique
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Tuesday’s announcement that UK prime minister Theresa May is calling for a snap general election caused a surge in the pound, but can sterling keep the ground it has recovered?


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UK prime minister Theresa May calling on Tuesday for an early election


Tuesday’s surprise sterling rally, after the announcement of a snap UK general election, could continue, with analysts predicting the “cheap” currency might even strengthen further against the greenback to break through $1.30.

However, the pound remains sensitive – its gains will be first tested on Wednesday, when the House of Commons convenes to vote on a June general election.

“We need a general election, and we need one now,” said May on Tuesday morning.

The news came as a shock to the British public – and markets – not least because her camp had repeatedly denied rumours of a snap election as recently as a month ago.

Sudden move

“The reaction of sterling … has been to rally subsequent to the announcement of an early election,” says Steven Andrew, multi-asset manager at M&G.

GBP/USD rose from a morning low of $1.2525 to $1.2762, while the pound strengthened against the euro from €1.1754 to €1.1928.

“The coming days will likely yield many explanations as to what sort of result this suggests is being priced in by markets,” says Andrew.

The Conservatives have boosted their poll lead against the Labour party from the low teens to 21 points in the past few days, according to pollster YouGov. Some 44% of those polled said they would vote for the Conservatives, if they had to vote in a general election tomorrow.

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Cable could even push through to $1.31, if polls start showing substantial gains for the Conservatives at the general election, says Christopher Turner, ING’s global head of FX strategy.

Stephen Gallo, the Bank of Montreal’s (BMO) head of European FX strategy, is even more bullish on the pound; the bank’s 12-month view of cable stands at $1.35. In addition, Gallo has an eye on EUR/GBP, due to the political divergence between the EU and the UK.

“The problem for the EU is that there are too many moving parts and crosscurrents – politically and economically speaking,” says Gallo.

Italy carries political and economic risks, France’s upcoming general election is too close to call, Germany has elections due in the autumn and struggling Greece is still lacking a comprehensive solution.

Meanwhile, barring a dramatic shift in the polls, it looks as if May will consolidate her support base when Britons head to the polls in early June.

The UK’s comparative growth, inflation and interest-rate situation, combined with the sharply weaker path already followed by sterling over the past year, suggest the currency is cheap and could rise from here, says M&G’s Andrew.

BMO’s Gallo says of EUR/GBP: “For the time being, I would look to sell a firm break of the £0.8400 level targeting a move to the £0.8320 area (stop at £0.8450). In the bigger picture, I would look to the £0.8550/£0.8600 range to offer good long-term resistance.”

Sensitive sterling

However, obstacles remain that could halt a meteoric rise in the pound, including the “cliff-edge Brexit risks, future of Scotland and lower UK rates for longer,” says ING’s Turner.

Scotiabank remains bearish on the pound, according to chief FX strategist Shaun Osborne, who says the bank is not sure sterling’s rally is sustainable and that any gains at the upper end of the trading range might be at risk.

“Sustained gains through the upper $1.26 [range] would change the broader complexion of the charts and suggest that we would have to treat the GBP rise a little more seriously,” says Osborne.

Stephen Simonis, chief currency consultant for FXDD Global, is also sceptical of the pound’s sudden ascent, which caught markets by surprise.

“While this election does seem a positive for the UK, a two-cent move seems like an overreaction and we look for the pound to return towards the $1.2550-$1.2600 level,” he says.

Nevertheless, the appreciation of the pound represents a turnaround for the beleaguered currency, which had until Tuesday attracted a swarm of short sellers and endured months of turbulence. As of mid-April, short sterling was one of the biggest trades in FX.

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The Commodity Futures Trading Commission’s latest speculators’ report shows that bearish bets against the pound pushed higher in April to just below the multi-year highs reached in March.

However, now traders are unwinding vulnerable short sterling futures positions and hedges, in light of its current appreciation.

The pound’s appreciation is not welcome news for UK exporters or British companies that derive much of their income from overseas, resulting in a 2.5% drop in the FTSE 100 on Tuesday.