Election uncertainty has begun to take its toll on sterling. After the leaders’ debate last week – which appeared to make the prospect of a coalition government less likely – the pound weakened.
Since the start of the year, the pound has fallen 4.4 per cent versus the dollar, and now some strategists are predicting a hung parliament will mean further falls for sterling.
The sterling-dollar exchange rate – known to traders as “cable” – “hasn’t factored in the ramifications of what’s happening here”, says Alastair McCaig of IG Index.
He is joining a growing chorus of analysts suggesting traders should go short sterling – or bet on the likelihood of the pound falling in value. So how will the election impact our currency?
The likelihood of no overall majority winner at the General Election stands at 89 per cent, according to analysis from IG Index.
“When it comes to the election, it is worth remembering that 326 is the magic number. If you are going to form a coalition, you need to reach that figure. At the moment we have the Conservatives at 287 seats and Labour at 274, and the way the markets have been going they will not get there either,” McCaig says.
The Labour party has said it will not go into formal coalition with the SNP, as it differs on major issues such as whether to hold another in-out referendum in Scotland. At the moment, the most likely election outcome is the formation of a Labour minority government, IG Index predicts.
For sterling, the bottom line is that “any minority government, whether Labour or Conservative, would be negative”, says McCaig. A minority government would have to get the Queen’s Speech passed through the Houses of Parliament, with Labour forced to rely on the informal backing of the SNP, and the Conservatives resorting to a “hotch potch of parties”. It would be a less stable government, with weaker authority.
“This debate is clearly unhealthy for... sterling and is bordering on the toxic,” says Simon Peck of RBS.
McCaig agrees: “Markets like to see a strong, confident leadership in whichever country, regardless of whether they agree with the policies.”
How far sterling could fall in the event of a hung parliament or formation of a minority government remains uncertain, but the run-up to the election is crucial for a trader.
“The ten days before and after an election are typically critical in terms of the market discounting political uncertainty,” explains Peck. Sterling-dollar is currently standing at $1.49, but he says there is a risk it could fall as low as $1.40.
Peck is advising clients to short the pound, as this is the “cleanest” way of playing the markets in this scenario.
He also emphasises that the risks surrounding sterling are not a binary event – whatever the outcome on election night, “a lot of the forecasting models out there show there could be uncertainty up until the Queen’s Speech on 27 May.”
NO SLAM DUNK
However, although there is uncertainty over the election, the UK economy does remain in reasonable shape.
Some experts say this fact alone means fears of a slump in sterling are overblown, and going short could be a mistake.
“The economy is working reasonably well. It is not a situation where we have people standing outside Northern Rock. There is no over-riding feeling that the UK economy is going down the drain, and that sterling will follow it,” argues Charles Purdy from Smart Currency Exchange.
“Shorting sterling versus the US dollar is not a slam dunk, and is something I would avoid.”
Investors interested in trading sterling should get in touch with a foreign exchange brokerage or spreadbetter.
Visit our General Election poll tracker to see how the polls changed in the build-up to election day.