UK election – GBP surge may last a while but…

Adrian Schmidt

So May calls and election, saying she’s fed up with having opposition from the – er – opposition, and also from the Lords. Someone should tell her an election isn’t going to have much impact on the unelected House of Lords, but it’s true it may have the desired effect on the House of Commons. In practice, she is likely to increase her majority because even though she may lose a fair few seats in the South to the Lib Dems campaigning on a Remain ticket, she looks like picking up a lot of Labour seats in the North, and also gaining votes from UKIP now the Tories have become the party of Brexit.

What I find depressing is the process of British politics. I suppose it is no surprise that politicians are power hungry – it is in their nature – and they will grab as much as they can given the chance. That is probably true pretty much everywhere, but let’s not pretend there is any higher motive for the election than that. But it is particularly depressing in the UK, where the first past the post system means the governing Tory Party already has a degree of power that is unrivalled is the vast majority of western democracies which generally have some form of proportional representation. The desire for an even bigger majority than the 17 the Tories currently have, so that there is no effective opposition at all (even within the Tory Party) is, in my view, faintly obscene, but that’s (British) politics. What is mystifying is why Corbyn and the Labour Party seem so happy to accede to her wishes. Sure, he was calling for an election after the referendum, but she refused. Now he should refuse. That’s the point of the Fixed Term Parliament Act. The timing of the election should not be based on the whim of the governing party (or any other party). His agreement to an election just underlines that Corbyn is a political idiot.

Anyway, it looks like May will get her wish and get an election and a bigger majority. The market consensus is that this is a good thing in practice, because it will give her more negotiating power at the Brexit table. This is true, in that there will be no election looming over her as the end of negotiations approach. However, the idea that she will take a more moderate and compromise friendly approach because she will be less dependent on her right wing looks a little speculative to me. It’s possible, but I don’t detect an air of compromise in her recent statements. I think it’s just as likely that the elimination of an effective opposition will allow the government to take a much more hard line approach. The security of the Conservative political situation domestically will allow them to indulge prejudices that are not necessarily optimal for the long term health of the economy.

While she will of course say she wants the best deal for Britain, what does that actually mean in practice? No-one really knows what the best deal is. Although the vast majority of economists believe something as close as possible to Remaining would be best economically, it is clearly not just about economics. In fact, it is probably not about economics at all. For politicians, the best deal is the deal that will given them the best chance of winning the next election with the biggest majority. The economic impact of Brexit may be large or may be small, but it will not be easily observable because there is no counterfactual. We won’t know what a good Brexit looks like any more than what a bad one looks like. We won’t know if Remaining would have been better. Even if the next election isn’t until 2022, the economic impact very likely won’t be clear by then.

But some things will be easier to measure. The level of immigration for instance. If the government manage to restrict immigration significantly they will probably benefit in the polls (regardless of whether that is actually beneficial). If they win the June election with an increased majority it seems likely to send them a signal to continue to work the nationalistic angle. This is not a conviction government. May has U-turned on Brexit and U-turned on an election. She will go with what works, and if she can sell an image of the UK battling for independence from a sclerotic Europe she will do it. I could easily be wrong here, but markets must beware of believing politicians are thinking about the economy. They are thinking about politics, and right now the economics isn’t clear enough (at least to the layman voter) for that to be the main factor.

As far as FX is concerned, for now at least, there’s no point bucking the market consensus. GBP is benefiting from the more positive view of Brexit, helped in large part by the heavy short positioning that has been evident for some months in the futures data. Some of that has now been eliminated, but the wind is still with the pound. I stick with the view that there isn’t much long term value in the pound here, but there may still be some more upside in the short term. In the absence of news from the US on tax reform the USD looks to be on the back foot for the moment, with expectations of Fed hikes fading, and we are likely to see GBP/USD gains beyond 1.30.  The EUR’s near term chances depend largely on the French election. If Macron gets to the second round he should win and the EUR should benefit modestly from this, but will suffer sharply if the run off is between Melenchon and Le Pen. On the positive EUR outcome I would see EUR/GBP as a buy below 0.83.

Looking a little further forward, the election may not be quite as smooth a victory as the polls currently suggest, and the current perception of the strength of the UK economy seems to be lagging behind what looks like a fairly sharp consumer slowdown in Q1. I would still be looking to sell GBP post election, or possibly before if the current euphoria dies down or we have some positive developments for the EUR or the USD.

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