Election tension leaves the pound cold

A new House of Commons will be elected tomorrow in the United Kingdom. Precisely because it is already almost certain that Labor will take over from the Conservative Party, it is remarkably quiet on currency markets around the pound.

The exchange rate of the euro in recent weeks has been determined more by what happens in European polling stations than by economic developments and the interest rate policy of the central bank (ECB). The currency took a hit last month due to Prime Minister Emmanuel Macron's unexpected announcement of French parliamentary elections. As a result, the euro lost almost 2% against the dollar in June. In the meantime, the debate between the mumbling American President Joe Biden and his challenger Donald Trump is the starting signal for a more turbulent course of the American currency. Before that happens, the British will cast their votes in the House of Commons elections next Thursday.

Political change
In the run-up to that voting round, there is no sign of unrest surrounding the pound. The calm course of action is largely due to the political change that is taking place. Because things must be very strange if Labor does not get a majority of the 650 seats in the House of Commons on Thursday. At betting shops you can only win 2 pence for every pound you now bet on a victory for the centre-left party. It would be the first time since 2010 that the United Kingdom will have a Labor Prime Minister. Not so long ago, financial markets would have held their breath at that prospect. The party has the habit of paying for all kinds of government investments that are popular with its supporters and of not being so strict with a decent budget policy.

Painful lesson
Party leader Keir Starmer has taken every opportunity in recent years to emphasize that Labor will pursue a very solid policy. Liz Truss's painful lesson in 2022 remains a good warning of what could happen if he is tempted to increase government spending. With the publication of a preliminary budget in which the deficit increased by 2%, Truss threatened to lose the confidence of the financial world. Government bond yields shot up and the pound took a big step back. Peace only returned when Truss withdrew her plans and subsequently resigned as prime minister. That was not the first time that Conservative Party policies caused turbulence on currency markets.

Peace at last
During negotiations leading up to Brexit in 2020, the pound fluctuated so much at times that traders jokingly referred to the British peso. During the reign of Rishi Sunak – who replaced Truss as prime minister two years ago – the currency has entered much calmer waters. Next Thursday's Labor victory will not change that. However, that does not mean that the pound is immune to a currency reversal. After the House of Commons elections, attention on currency markets will shift to the interest rate cuts that the Bank of England will implement later this year. If the unrest surrounding the euro subsides in the aftermath of the French elections, the pound could easily take a step back towards the autumn.

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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