What’s the outlook for sterling ahead of the UK general election?

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Capital Economics has raised its forecast for sterling ahead of next month’s UK general election to $1.30 by the end of the year, while it expects the currency to benefit from strength in the euro.

However, the research consultancy’s rosy outlook is not shared by all market observers.

The improved forecast comes off the back of speculation that Brexit “might be less bumpy than previously feared” and that the UK’s relative economic performance “could strengthen further”.

It comes despite the ONS this morning revising down UK GDP growth to 0.2 per cent.

Capital Economics chief economist Jonathan Loynes forecasts sterling will rise to $1.35 in 2018 and $1.40 by 2019. Capital Economics’ previous forecasts had been $1.20, $1.30 and $1.35 for each respective year.

Loynes warns the improved outlook for Brexit negotiations could deteriorate “if expectations of a much increased Conservative majority after the general election are not met”.

However, he adds “the pound will no doubt continue to act as a valuable shock-absorber should the economy weaken or the Brexit negotiations take a turn for the worse”.

Loynes says sterling is more closely correlated with the euro than the dollar and expects it to stay at current levels with the single currency. It currency sits at €1.1557.

UK equity picks

However, Sheridan Admans, investment research manager at The Share Centre says there are “a lot of moving parts” to currency that make it risky betting on one direction.

As well as Brexit negotiations and the election result, sterling is also affected by the current account balance of payments, economic growth and relative inflation rates, Admans says.

The Share Centre currently favours early-stage and mid-caps for its UK assets.

“The first have portfolios of UK companies that are in such early stage growth they have some insulation from such uncertainty over the short to medium-term like Neil Woodford’s Patients Capital Trust.

“The second are fund managers in the mid-cap space that have good exposure to overseas earners receiving their revenue in foreign currencies, such as Royal London UK Mid-Cap Growth fund.”

Sterling weakness can lead to M&A opportunities in the mid-cap space, while if sterling rises the asset class offers greater diversification from overseas earners than the FTSE 100.

Sovereign risk 

The fact that credit portfolio managers are even talking about the impact of the general election disproves the idea that sovereign risk is the providence only of emerging markets, says co-head of credit at Hermes Investment Management Mitch Reznick.

“A result that weakens the pound would reflect a need for greater risk premia for UK assets. As a result, we would also likely see a widening of credit spreads in mostly-domestic, UK-domiciled names.”

Reznick says it is important to remain global to manage the impact of sovereign risk.

David Katimbo-Mugwanya, manager of the Amity Sterling Bond fund at EdenTree Investment Management, says election outcomes will be assessed vis a vis the prevailing tone of Brexit negotiations.

A surprise election result in favour of the opposition would increase risk aversion, thereby supporting government debt and further entrenching a ‘lower for longer” stance on interest rates. In those circumstances, sterling can be expected to trade with a downward bias.”

However, 7IM argues an increase in support for Labour and the Liberal Democrats could see sterling surge on the prospect of a lack of appetite for Brexit.

It argues the most negative scenario for sterling would be the Government maintaining its current majority meaning Theresa May doesn’t have the stronger mandate to face down “hard-core” Brexiteers.