Will the election shock in the UK be greater than in the US?

The British Pound is in for a wild ride. It is only a matter of time before Prime Minister Rishi Sunak has to call an election. The outcome of this seems almost certain, but that does not apply to the course of the next government.

The pound was one of the surprising currency winners of 2023. Although the currency lost slightly against the euro, it rose 5% against the dollar and even by more than 10% against the yen. The strength of the pound has little to do with what is happening in the British economy. The United Kingdom narrowly avoided a minor recession in the second half of the year. But on balance, GDP has grown less than 3% since 2019. For the current year, economists expect economic growth of only 0,5%. However, in currency markets, interest rates often play a greater role than the economy.

Idiosyncratic interest rate
The British central bank started raising interest rates earlier than, for example, the Federal Reserve and the European Central Bank. Since the beginning of August, the Bank of England (BoE) has kept the policy rate stable at 5,25%. And unlike the US central bank, for example, the BoE is not yet planning to cut interest rates again any time soon. The latest policy notes indicate that the current rate is likely to remain at the same level until the third quarter. After that, interest rates may gradually fall towards 4,25% in 2026. If the BoE maintains this policy, a growing interest rate differential with the dollar and later also with the euro will again be a tailwind for the pound this year.

Changing of the guard
However, it is only a matter of time before the focus shifts from interest rate movements to the British elections. Just after New Year's Eve, Prime Minister Rishi Sunak already hinted that the British will go to the polls this year. He does not have much choice, as the previous elections were five years ago in December. The great uncertainty lies not so much in the timing of the elections or even in the results. Because due to the economic malaise and inflation that has been even higher than on the European mainland in recent years, the British are completely done with the conservatives who have been at the helm since 2010. The big question is what the Labor Party will do if it gains power.

Financial space is limited
It has been more than thirteen years since Labor was last in office. Moreover, faction leader Keir Starmer does not shy away from his plans. There is therefore a good chance that the pound will move considerably in the run-up to the elections. Moreover, the chance that the Labor Party will take an extreme course is quite small. The financial space is limited, as financial markets will react strongly if the national debt threatens to increase rapidly. And the interest rate policy is not set by the government, but by the independent Bank of England. Although there will undoubtedly be a lot written about the British election during the course of the year, there is a good chance that it will fizzle out in terms of currency. Pending the elections, the pound is still on hold for the time being.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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