British Pound Slides as U.K. Vote Springs Hung Parliament Before Brexit

LONDON (Capital Markets in Africa) – The pound headed for the biggest drop in a year after it emerged that the ruling Conservative Party has fallen short of an overall majority, just 10 days before Brexit negotiations are set to begin.

The currency slumped against all of its major peers as Theresa May’s Tories were set to miss the target of 326 seats needed to form a majority government, contrary to what many polls were predicting and the market expected. Still, it avoided dropping below $1.24, which the median estimate of analysts surveyed by Bloomberg had predicted under such a scenario. U.K. stocks rose for the first time in five days, while government bonds fell for a third day.

The result means there will be a period of uncertainty while the country, the European Union and investors await who will be at the helm during two years of EU exit negotiations. Sterling hit its lowest level versus the dollar since April after the first exit poll on Thursday predicted the Tories winning just 314 seats.

Should the Conservatives fail to form a workable government, it will be up to opposition Labour leader Jeremy Corbyn to try and form a pact with the pro-European Liberal Democrats and Scottish National Party, a potentially unstable alliance but one that could also boost market hopes of a softer Brexit.

“Investors will await more clarity on who will be running the country and who will be in charge of the Brexit negotiations,” said Valentin Marinov, head of Group -of-10 foreign-exchange strategy at Credit Agricole’s corporate and investment banking unit in London. “We still see scope for a GBP/USD move toward 1.25 and EUR/GBP toward 0.90,” adding that the bank would be reviewing its near-term forecasts.

Both the Conservatives and the Labour Party spent little time debating the country’s exit from the European Union, with the latter focusing its campaign on anti-austerity promises. The pound has borne the brunt of the U.K.’s decision to leave the European Union, having lost about 15 percent of its value against the dollar since the June 2016 vote. Fewer than five seats are yet to be announced.

The pound slumped 2 percent to $1.2702 as of 8:45 a.m. London time on Friday, after touching $1.2636, the lowest level since April 18, the day May called the snap election. It slid as much as 2.5 percent, set for the biggest drop since the days after the Brexit vote. The decline in sterling has already taken it below analysts’ median forecast of $1.28 by year-end. Against the euro, the pound tumbled as much as 2.3 percent to 0.8860, its weakest level since November.

Pound Scenarios
Despite the hung parliament outcome, sterling did not fall as low as some expected. A Bloomberg survey of 11 banks and brokerages conducted before the exit poll showed that sterling could plunge to as low as $1.20 on Friday while the median forecast for a level of $1.2350. That could either be because investors are awaiting who will form a government, or on the promise that Conservative Party weakness could result in a softer Brexit.

The FTSE 100 index of shares advanced 0.9 percent, the most in Europe. The gauge gets more than two-thirds of its sales from abroad, so the weaker pound typically bolsters the measure. British American Tobacco Plc and GlaxoSmithKline Plc were among the biggest gainers, while companies with a larger exposure to the U.K. dropped.

The pound’s weakness is “an uncertainty discount, rather than pricing the fundamentals of a potential leftist shift in the U.K. government, with a softer Brexit stance,” said Peter Chatwell, head of rates strategy at Mizuho International Plc in London.

“If this exit poll solidifies into reality then this market reaction should be ‘Trumpian’, i.e. on realization of a softer Brexit stance and more fiscally easy outlook, we should be factoring in greater growth and inflation and gilt supply, generating a steeper gilt curve and stronger sterling,” Chatwell said.

U.K. 10-year gilt yields rose three basis points to 1.062 percent.

For others, the result leaves the country little further forward than before the decision to call a snap election. It also raises the possibility of a further election before the year-end.

Source: Bloomberg Business News