The UK Election Result and Sterling

The decision of Theresa May to call a snap general election in the UK caught almost every commentator by complete surprise. Although the political logic of calling an election against an almost historically weakened opposition party had been obvious for some time, pundits and politicians alike appear to have taken the Prime Minister at face value when she insisted, on multiple occasions, that she had no intention of calling such an election.

The more cynical amongst us might wonder what’s supposed to be quite so shocking about a politician saying one thing and then doing the exact opposite, but the degree to which experts appear to have been taken by surprise needs to be kept in mind when considering the effect which the election announcement had on the strength of sterling, and the impact which the eventual result of the election is likely to have going forward.

Movements

The initial response to the announcement was a 2.7% boost to the pound, lifting it to six month high against the dollar. We’ve seen throughout history that the two currencies can fluctuate on the merest political move but, after a subdued period following the EU referendum, there seemed to be genuine optimism for sterling’s recovery.

Much of this increased optimism regarding sterling was based on two assumptions. The first of these assumptions is that Theresa May will be returned as Prime Minister with a much increased Tory majority, and will thus be in a much stronger position when engaging in Brexit negotiations with the EU. The polling evidence for this result seems, at the time of writing, to be all but overwhelming.

It has to be remembered, however, that following the 2015 general election and the Brexit referendum, the reputation of the UK polling companies has never been lower. Allied to this is the fact that looks set to be a general election fought largely on the basis of one issue – Brexit. The degree to which the 48% who voted for remain will opt for the most pre-European option on offer to them remains to be seen, and various attempts to turn the general election into a re-run of the referendum have already emerged. These range from the Green Party floating the predictably doomed idea of cross-party co-operation on the matter to the campaigner Gina Miller using crowd-funding to raise (at the time of writing) in excess of £300,000 intended to fund a tactical voting initiative in support of pro-European candidates.

Easy ride?

There’s every chance that these factors won’t have a major impact upon the election result and that the expected coronation of Theresa May will take place, but they do underline the degree to which the final result can’t be taken for granted. The other key factor is the size of any Tory majority. The thinking of the currency markets seems to be that a larger tory majority will enable Theresa May to ignore the more extreme advocates of Brexit – those backbenchers who would rather crash out of the EU with no deal whatsoever – in favour of pursuing a ‘softer’ Brexit with a longer transitional period and more access to European markets.

There are three major problems in allowing this line of thinking to take too firm a grip, however. The first is that anything other than a crushing tory majority – in excess of 100 seats for example – would inevitably be regarded as a disappointment and would puncture the mood of optimism, if only temporarily. Given the Brexit-centric factors listed above, this is an outcome which can in no way be discounted. The second factor is the size of the hardcore anti-EU factions within the party which might push for an exit at any cost. Whilst there are around 20 MPs who have directly rebelled against the government on many European issues in the past, sixty backed a petition to leave the single market in 2016.

Throw the expected new intake into the equation – many of whom may have benefited from a swing back from UKIP – and you have a situation in which a majority of more than 100 MPs wouldn’t only be psychologically important, it would also represent possibly the lowest figure which would make it possible for May to pursue a more ‘compromised’ vision of Brexit.

Leader

The final fly in the strong pound ointment is Theresa May herself. This, remember, is a Prime Minister who campaigned (albeit very quietly) for Remain, only to embrace Leave once she became Prime Minister. This is also the person who vowed not to call a snap general election repeatedly until she decided to do so, and one who ran fairly hard-line anti-immigration policies when Home Secretary and has since indicated a desire to place controlling borders above the economy when negotiating a post-Brexit settlement.

It therefore seems somewhat blasé to base any long term confidence in the strength of the pound upon an assumption that Theresa May will do the ‘sensible’ thing when Brexit actually occurs. After all, as far as the currency markets are concerned, the sensible option would have been not to call a referendum in the first place.