FX: Weaker sterling here to stay

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By:
Farah Khalique
Published on:

From strong and stable to weak and jittery, the pound bore the brunt of the surprise UK general election result, but despite May’s quick move to form a working coalition government, sterling will likely stay soft, say analysts.

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Sterling’s fortunes have reversed since the announcement of the snap election in mid-April, burning those who had priced in an appreciation of the rallying pound.

Prime minister Theresa May was predicted to comfortably win a Conservative majority, but seven weeks is a long time in politics, and the Tories ended up scoring an own-goal by losing 13 seats.

The result left a hung parliament, as no party won enough seats – 326 or more – to secure an outright win. The Conservatives won the majority of the vote – 318 seats versus Labour’s 262 seats – and are working on building a coalition with Northern Ireland’s Democratic Unionist Party.

Regardless, analysts say sterling is on shaky ground.

Cable – the pound against the dollar – fell from a pre-election level of $1.2956 to $1.2653 in the early hours of Friday, before cautiously rebounding.

Hetal Mehta, senior European economist at Legal & General Investment Management, says: “The sterling/US dollar exchange rate is currently hovering close to $1.27 as markets appear to have been anticipating a larger majority.”

The pound also briefly slipped against the euro, with EUR/GBP rising to a high of £0.8858, before recovering somewhat to current levels of around £0.8769.

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Caroline Simmons,
UBS

Caroline Simmons, deputy head of the UK investment office at UBS Wealth Management, says: “Given the lack of clarity on domestic policy and the impact on the Brexit negotiations, we expect sterling to remain soft. This should remain supportive of the equity market, under a Conservative minority outcome.”

UBS Wealth Management advises its investors to pursue a strategy of diversified dividends, whereby investors can capture the UK dividend yield of 4% while investing across a broad range of sectors in globally diversified companies.

Choppy times ahead

The overwhelming theme for sterling now is that of uncertainty, says Jane Foley, senior FX strategist at Rabobank.

May has sought permission from the Queen to form a government, but a questioín mark nevertheless remains over her long-term future.

Foley says: “It is clear that the knives are being sharpened within her own party and she may not be able to hold power for long.”

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Jane Foley,
Rabobank

A quick formation of a new government would be positive for sterling, says Foley, but any delay to the start of Brexit talks on June 19 “will not be welcomed” by markets.

She says: “Although hope for a softer Brexit have likely prevented a more drastic plunge for the pound this morning, a choppy period is in store.”

Geoffrey Yu, UBS’s head of the UK investment office, is a little more upbeat.

He says: “[Cable is] trading well above before the election was called. This doesn’t mean things are suddenly looking worse than after [the vote for] Brexit. It is nuanced in terms of viewing how the FX market is reacting.”

Trading opportunities

Dutch bank ING’s FX strategy team is cautiously confident of a stronger pound, in time.

The loss of Conservative seats – and subsequent rise of Labour’s foothold – suggests the dial within the UK parliament might tilt towards a softer core Brexit view, with some hard Brexit pushback.

They say: “This subtle change makes long GBP positions attractive as a lot of bad news seems to be priced into a heavily undervalued GBP.”

A softer Brexit deal, along with the possibility of the pound remaining soft, should help support the FTSE, says Fawad Razaqzada, market analyst at Forex.com.

For traders that want to dabble in FX derivatives, ING advises buying a six-month cable call spread with a strike of $1.3200 while simultaneously selling a six-month cable call spread with a strike of $1.3600.

Call spreads are used when a moderate rise in the price of the underlying asset, in this case the pound, is expected. This trade offers a maximum return of 3%.

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Robert Bergqvist,
SEB

In the meantime, analysts agree that questions around Brexit will only continue to grow. The snap election means the UK can continue Brexit negotiations with the EU beyond the spring 2019 deadline, without worrying about a UK parliamentary election that was scheduled for 2020.

However, May is weaker in the Commons now than before the election, and Brussels might also perceive her as weaker, says Robert Bergqvist, chief economist at Swedish bank SEB.

“The outcome could be interpreted as meaning that the PM does not have such strong backing for her mantra that Brexit means Brexit,” he says.