Theresa May's Conservatives are favourites to win the General Election, so what will happen to sterling if the Tories win?

Jasper Jolly
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Ministers Attend David Cameron's Last Cabinet Meeting
Theresa May's odds of winning a bigger majority have been slashed (Source: Getty)

Despite the dramatic narrowing of Theresa May’s poll lead over Labour's Jeremy Corbyn, polling averages still show the Conservative party winning this week’s General Election. But a Tory victory could still be the trigger for big moves in the pound.

Even if May emerges as Prime Minister on Thursday night currency traders will be scrutinising the size and composition of her majority; economists predict the prospects for sterling will depend on the strength (or otherwise) of May’s hand in Brexit negotiations.

All eyes will be fixed on Ipsos Mori’s exit poll, revealed when voting closes at 10pm, to see if that persistent poll lead turns into reality.

Relief rally

The base case for most analysts is still a Tory majority somewhere in the 40- to 70-seat ballpark (an improvement on their current 330 out of 650 members of Parliament).

If that is borne out on Thursday night an upward movement for sterling against other major currencies would be the obvious reaction.

Read more: Labour wins the General Election. What happens to the pound?

“We could see a modest relief rally” to somewhere above $1.30 against the dollar, says Lee Hardman, a currency analyst at MUFG.

Sterling has already visited that region for the first time since September last month, but has since struggled to sustain those levels. “If we were to see that more comfortable majority for the government that could be the trigger,” says Hardman.

Brexit questions

Sterling jumped from around $1.25 to break $1.29 on the evening of Theresa May’s shock snap election announcement. That sterling surge was based on the polls at the time, which showed an average lead of around 16 percentage points for the Conservative party, according to Britain Elects, which would translate into a majority of landslide proportions – and possibly a slightly easier task for May in the vital Brexit negotiations.

A bigger majority for May would theoretically make her less beholden to the right wing of her party, many of whom are more Eurosceptic Tories who favour a harder Brexit, with a cleaner break from the current trading relationship.

May voted for Remain in the EU referendum barely a year ago, but has already announced the UK will leave the Single Market. A majority of 50 or above would allow her to “pursue the Brexit she wanted”, says Paul Hollingsworth, a UK economist at Capital Economics.

A status quo vote

Many economists think a bigger majority is mostly priced in, so the potential for a big spike in sterling may be limited, says Hollingsworth. However, “the chances of a surprise are probably skewed to the downside,” he adds.

A smaller majority than predicted could see sterling fall as traders scramble to reposition, with markets so far buying little in the way of protection for a move downwards.

Jeremy Cook, chief economist at World First, says: “Anything less than a 50-seat majority, we’re looking for a one per cent fall in sterling.”

Read more: General Election 2017: How will markets react to a May or Corbyn victory?

Yet a Tory majority would still be a continuation of the current situation (and, indeed, the situation in which May previously insisted there was no need for an election).

“Markets have largely priced in the Tories’ direction of travel on Brexit – leaving the Single Market and Customs Union,” says Peter Ashton, managing director at Eiger FX. “A narrow or not much changed majority for the Tories would have a somewhat muted effect on sterling.”

However, anything but an improved majority would be politically harmful, even in the case of what would in most other circumstances be seen a comfortable victory. In the longer term this could “deplete May’s reserves of political capital” in Brexit negotiations, Ashton adds.

A small majority would turn attention back to the composition of May’s MPs, says Cook, and the parliamentary calculus of a small majority during sensitive negotiations.

Hung parliament

Then there’s the possibility – if still the definition of a long shot – of a hung Parliament.

If there’s one consensus among economists and traders, it’s that the increased uncertainty of a hung Parliament would lead to extended sterling selling, as all eyes turn to complex coalition negotiations.

Read more: What happens if there's a hung parliament?

The 2010 election in which the Conservatives failed to win a majority saw a two per cent slump in sterling against the dollar on the day after the election, according to Bank of England figures.

That was reversed in the next trading session as the coalition horse trading went on. This time, however, with Brexit negotiations with the EU looming, anything but a Tory majority will trigger another massive bout of volatility to cap a year of political earthquakes.

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