Julius Baer unpicks FX market optimism on UK election

Julius Baer has rejected FX market optimism that Prime Minister Theresa May’s call for a snap election will lead to a softer Brexit or that a longer parliamentary term for the Conservatives will help negotiations with the European Union.

The pound surged 1.5 per cent on the euro following May’s surprise announcement, but the private bank maintains its bearish outlook for the pound at EUR/GBP 0.89 in the next year.

After a sharp sell-off ahead of May’s announcement, the pound surged to a five-month high $1.2729 against the dollar, from a low of $1.2513.

Economist David A Meier says markets are excited about the pound for two reasons.

“First, the postponement of the previous next elections from 2020 to 2022 allows more time and flexibility for the Brexit process, avoiding the possible scenario where either a prolongation of the talks beyond March 2019 or a very hard Brexit (no seamless trade deal reached with EU) create political turmoil in 2020,” Meier says.

“Second, the chances for May’s Tories to win a considerably larger majority are big, as polls show higher approval ratings and a (still) supportive economic backdrop.”

Meier says FX markets believe a large share of Conservative MPs will dilute the ones advocating a hard Brexit.

However, he raises doubts about both reasons.

“First, the relaxed timeframe looks compelling, but mainly from the UK’s side. Across the Channel, the EU is facing parliamentary elections in 2019 and will surely want to seal a deal beforehand.

Meier continues: “Second, we do not believe that Prime Minister May is willing to soften her Brexit stance before negotiations with the EU commence – from the perspective of political capital building, this makes little sense.”

Making concessions on immigration policies nullifies the purpose of the Brexit itself, Meier argues adding there is no guarantee that newly elected Conservative MP’s will be softer on Brexit.

“In our view, it is more likely that May is trying to secure political backing in case her hard Brexit plans fail, which, however, would probably end her career as PM instead.

“Last but not least, it is very difficult to assess how many additional seats the Conservatives will actually win, as the single-district ‘winner-takes-it-all’ electoral system makes predictions very difficult.”