Pound sterling to find support from softer Brexit hopes say City analysts

The prospect of a softer Brexit could support the value of the pound despite rampant fears of political instability in the wake of the Conservative party’s electoral disaster, according to City of London analysts.

Sterling shed almost 2 per cent against the dollar to $1.2731 immediately after the bombshell exit poll was published at 10pm on Thursday night and fell as low as $1.2664 on Friday morning - putting the currency on course for its biggest drop since last October.

It recovered slightly in the afternoon to trade at $1.2727, after Ms May said she would continue to govern with the support of the 10 MPs of the DUP

“When we saw reports that May was going to stay on as Prime Minister at about 8am sterling dropped. This is suggestive of a perception in the market that with May having lost her majority a soft Brexit is again a possibility,” said Jane Foley, head of FX Strategy at Rabobank International.

She pointed out that the DUP has made it clear that it does not want to see trade obstructed on the Irish land border by new customs checks, which would seem to rule out a "cliff-edge" Brexit in 2019, where the UK leaves with no customs or trade arrangements in place and simply falling back on World Trade Organisation [WTO] rules.

“[Sterling] hasn’t weakened to the sorts of levels that many were talking about if there was a hung parliament [which] suggests that this perception that a soft Brexit is a bit more likely is coming into the fray,” she added.

Supported by hope?

Reuters Eikon

“The election result has reduced the likelihood of a hard Brexit, which is economically positive for the UK and Europe,” agreed Mark Burgess, of Columbia Threadneedle Investments.

“A softer approach to Brexit could see potential structural support for sterling down the line. It seems reasonable that any Brexit deal will now be subject to greater Parliamentary scrutiny and the government is more likely to seek to retain some elements of single market access.”

But Kevin Gardiner, global investment strategist of Rothschild Wealth Management, urged caution over this interpretation.

“Some commentators are making a soft Brexit, or even a second EU membership referendum, more likely, but we should not take this for granted. There are two parties to the Brexit negotiation and we think it is wrong to assume any UK Government can pick its preferred outcome.”

Mark Horgan, the chief executive of the foreign exchange service Moneycorp, stressed that sterling was already down around 15 per cent since last June’s referendum.

“What we’ve got in the price right now is the current situation. The next half point for sterling is if you do or you don’t get a hard [WTO] Brexit. That’s the next point where Sterling’s going to get hit.”

“Where we are now is a very difficult position for continuity. My view of the disaster scenario is Theresa May hangs on until October, then she gets turfed out in the Conservative conference, then the Conservatives lose a vote of no confidence, we’re back into an election in November. Forget about Brexit negotiation at that point in time because we just don’t have the people to execute.”

“Volatility is going to be higher to reflect the short and medium term uncertainties about Britain’s political and economic future,” said Chris Iggo of AXA Investment Managers

“If the government sees the need to be more populist on the domestic side then this will mean more spending and more borrowing. The relaxation of fiscal austerity should lead to the steepening of the gilt curve.”

Ten year gilt yields – which move inversely to prices - yesterday spiked early yesterday as high as 1.064 per cent, but fell back to 1.035 in the afternoon.

Mr Horgan of Moneycorp said that his company had seen a three-fold increase in trading volumes relative to a normal day.

But he added that Moneycorp’s clients - mainly small firms seeking to hedge their foreign exchange exposure - had learned the lesson from last June’s Brexit vote, which sent the currency down a record 10 per cent in one day.

“Everybody’s been less caught out – there’s been a huge increase [in hedging] since Brexit. If you’ve got a business making 10 per cent net profit and 10 per cent disappears in a currency movement you’re focused on not letting that happen again.”