The logic, it seems, is that in most scenarios the pound should weaken.
A Conservative-led government is likely to lead to long period of uncertainty leading up to an EU referendum, while a Labour-led government raises questions about the UK’s fiscal position and a change in the timescale for addressing the current account deficit.
Still, amid the uncertainty sterling has rebounded in recent days (to $1.53 as at 6 May) and, for Paul Niven, manager of Foreign & Colonial Investment Trust, this owes much to do with investors’ tactical positioning and technical unwind.
In for a pounding?
“While there are certainly good arguments which say sterling should weaken, I wouldn’t look for a collapse but certainly look for it to decline,” he says.
“On the other hand there are maybe some reasons people are underestimating the currency in terms of potential strength. For example, ECB quantitative easing is depressing yields and is leading people to look for higher yielding assets and the UK in that context can attract capital.
“Also, if we do get a Labour-led government then arguably rate rises are going to come sooner and that firming up of rate expectations may be something of a supportive factor for sterling as well.”
A protracted period of awkward dialog among parties over which coalition could lead the UK forward is unlikely to help the currency, which may well take a big hit in the coming days.
Until two weeks ago, sterling had been quite weak against the dollar but strong against the euro. More recently, it has been depreciating against the euro.
“To put it simply, a certain amount of downside has already been priced in,” says Ugo Lancioni, portfolio manager, global fixed income and currency at Neuberger Berman.
“We don’t need to turn to the general election to explain that downside: while it remains one of the better economic performers, recent data out of the UK has been soft – Q1 GDP growth clocked in at 0.3%, versus a consensus forecast of 0.5%.”
Eurozone catch up
Moreover, he believes there are reasons for optimism on sterling: “The eurozone is due a bit of catch-up, and evidence of an improving situation there and the positive impact expected from the ECB’s QE may account for sterling’s recent weakness against the single currency.
“However, in the longer term, this should be positive for both sterling and the UK, a very open economy heavily exposed to European demand, as long as the new government positions the country to capture the opportunities that come from recovery on the continent.”
Still, for Peter Toogood, investment director at City Financial, it has been a big surprise that the pound appreciated so strongly against the dollar last week and that UK equities have endured such a strong period of outperformance relative to global indices.
He says: “In our view, the likelihood of a period of post-election uncertainty – and the fact that Labour appears to have the upper hand in forming the next government at this stage – makes UK markets vulnerable to a correction relative to their global counterparts.”
