A hung parliament leaves sterling once again at the mercy of events in Westminster – a position that has become familiar since the vote for Brexit almost a year ago.
Investors are forced to contemplate a new series of destabilising scenarios for the UK, including the possible exit of Theresa May as prime minister and another general election, not to mention Brexit negotiations that are due to start in less than a week.
Markets are still scrambling to work out what to think of the shock election result. In the early trading hours after the polls closed, the pound sold off 2.5 per cent. But as political chatter about Mrs May’s diminished status turned on Friday morning to what the result meant for Brexit, sterling enjoyed a 1 per cent bounce. The idea began to emerge that a chastened Conservative government would have to take a more conciliatory approach towards leaving the EU.
The appointment over the weekend of the pro-European Damian Green as unofficial deputy prime minister and the retention of chancellor Philip Hammond, seen as pragmatic on Brexit, offered some encouragement that a shift in the UK negotiating stance might be forthcoming.
Come Monday, and the mood again turned sour. Sterling once more slipped below $1.27 and weakened towards 89p against the euro, as concern at the scale of the political uncertainty in Westminster, rather than hopes for a “soft Brexit, ” dominated.
“I thought sterling would bounce a bit because the market would think the chances of a soft Brexit had gone up,” says Paul Lambert, currency manager at Insight Investment. “What’s undermining sterling is the political situation has become chaotic. You couldn’t make it up. You have a very unstable equilibrium and the chaos may lead to a hard Brexit.”
Having expected to see Mrs May cement her position with an enlarged parliamentary majority, investors – particular sterling bulls – remain in a state of bewilderment.
“For an optimist like myself, the recent events in the UK are difficult to accept,” says Stephen Jen, of the macro hedge fund Eurizon SLJ Capital. “This was wholly self-inflicted and unnecessary.”
Marvin Barth, Barclays’s head of currency strategy, was another who came into the election optimistic about the pound’s prospects, but who has now closed his long positions on sterling and is reviewing his forecasts.
The political uncertainty undermining sterling also made a sharp contrast with the political stability strengthening the euro. As Emmanuel Macron consolidates his grip on France, the euro continued its rise.
According to Kathleen Brooks at City Index, “it looks increasingly like Europe has its house in order, and the Anglo-US world order looks like it is heading for the cliff edge”. The meeting on Tuesday between the French president and the UK prime minister, with Brexit top of the agenda, has added piquancy.
Rather than focus on likely Brexit outcomes, investors should concentrate more on the political dynamics at Westminster. As Simon Derrick at BNY Mellon points out, sterling has bounced this year at moments that appear to have clarified the UK political landscape — Mrs May’s Lancaster House speech in January on her Brexit plan and her decision in April to call the election.
“It is therefore hard to see it performing well over the summer given the possibility that the current state of political uncertainty could last for a number of months yet,” Mr Derrick says.
The other new political dynamic influencing investors is that Labour leader Jeremy Corbyn is emboldened. Adrian Owens at GAM says the Labour leader and his party have moved from being “largely irrelevant in the eyes of investors to becoming a more realistic threat to the economic stability of the UK”.
That might be manageable in a benign economic climate, Mr Owens adds — yet interest rates are unsustainably low, inflation is hurting consumer spending, a hung parliament may weaken the fiscal position and the current account deficit is too high. “More immediately, growth also appears to be slowing,” Mr Owens says.
Labour’s better than expected electoral performance is another reason why investors should not get too carried away with the idea of a softer Brexit. “Corbyn is also pro-Brexit,” says Mr Jen. What do investors think about sterling now? Mr Jen thinks many of them are “confused, because of all sorts of conflicting factors and forces”.
As Monday finished, pessimism was again the dominant sentiment towards the pound. Mr Lambert thinks only a government of national unity can negotiate a reasonable Brexit outcome and restore stability to the pound, but he doubts it will happen.
For now, investors are sure on one thing, Mr Lambert believes: “It’s clear that the UK doesn’t have a plan.”