Sterling rally hardly sustainable

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David A. Meier, economist at Julius Baer

Against the backdrop of remaining political risks, the pound sterling’s ‘relief rally’ will hardly be sustained. In addition, the prospects of a later Bank of England rate normalisation are a further reason for us to keep our pound stance bearish.

Large was the eye-rubbing Friday morning when the Conservatives’ (Tories) smash-victory in the UK general elections became visible. Markets had expected a ‘hung parliament’ based on public opinion polls, which had showed a head-on-head race between the Tories and the Labour parties, with the smaller parties preventing a clear majority.

However, the ‘first-past-the post’ system makes it very difficult for predictions based on public opinion polls, as it makes it difficult for the small parties to, in fact, enter the parliament.

As the news of a majority-led political leadership unfolded, the pound rallied immediately on Friday morning. We however put a question mark behind the sustainability of this rebound. While, admittedly, the risks of political instability have been removed, as well as the risks of a Labour-led coalition leadership worsening the UK’s fiscal metrics, other political risks remain.

The Tories’ election promise, an EU-exit referendum, seems now very likely to come (probably in 2017). Furthermore, the large fraction of the Scottish National Party in the parliament could revive separation desires. In addition, the Tories focus on continuation of fiscal austerity measures could keep the necessity of an early Bank of England rate normalisation limited.

 

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