Marius Paun | London, UK | Senior dealer | Wednesday, 11th December 2019
There is little doubt that since the Brexit referendum, back in 2016, the fate of pound sterling and UK stocks both have been closely intertwined with the political process, to an extent rarely seen before. As you may know by now, to the surprise of most global observers, the Brexiteers camp won it by 52% versus 48% for the Remainers. However, the delivery process has proved by no means an easy affair. Initially, the UK was due to conclude the withdrawing from Europe on March 29th 2019. But that did not happen. There were a few exit deals negotiated by the UK Government with the EU, which were subsequently declined by the UK Parliament one by one. Instead, the UK government had to go back and ask for an extension and come back with another supposedly better deal.
It must be mentioned the majority of UK members of Parliament were Remainers rather than Brexiteers and that was possibly the main reason the delivery process has failed so far. The GBPUSD followed those failures and slumped from a high of 1.5016 seen in June 2016 to as low as 1.14 on October 2016 when Prime Minister Theresa May gave her infamous bad speech, which was followed by a flash crash during Asian Trading session which saw the pound losing 6% against the dollar. Eventually, May resigned and Boris Johnson took over and surprised the markets when he came back from Europe with a new deal. In reaction, the GBPUSD rallied from a low of 1.21 to around 1.29.
Despite Parliament demanding amendments to the old deal (very few thought it would ever happen) when it came to the vote, they failed, yet again, to ratify it. So, the Brexit deadline was extended yet again and is currently January 31st 2020. Despite the last pushback the 1.29 level held rather well. Feeling the country is stuck in no man’s land and in an attempt to address the lingering uncertainty, Boris Johnson triggered a general election.
There were too many voices asking for a second referendum blaming Government lies during the campaign for the first Brexit vote and/or voters not understanding what they were voting for. In effect, some see elections as a proxy for the second referendum given where main political parties sit. If the Conservatives win, there will be some kind of Brexit. If Labour wins, it seems the UK public will get to vote officially on a second referendum but Labour will be in the remain camp. If the Liberal Democrats win, there will be no Brexit at all.
During the last few weeks, the election polls had a significant impact (mainly positive) on the sterling pound. It recently broke above the psychologically important 1.30 to the US dollar, rallying close to 2%. It was the biggest gain since October on the back of polls continuing to indicate a 10-point lead for Boris Johnson’s Conservatives party over Labour. That is seen favourably by global markets as Tories are considered the most pro-business choice. They are also the most likely to put the Brexit subject to rest, quicker than other parties. Nonetheless, polls can be misleading if recent history is anything to go by. Just think the double surprise of Brexit referendum and US Presidential elections.
If anyone doubted that Thursday’s elections are the main driver for GBPUSD currently, trumping the economic data, look no further than the latest figures. Last week the PMI pointed to contraction in the UK manufacturing, services and construction sectors. On top of that on Tuesday, the monthly GDP came in flat. Yet the GBPUSD stayed close to the recent highs around 1.32 mark.
Let’s look at the chart and discuss possible scenarios:
The most likely outcome is a Conservative majority which will open the doors for Brexit to move into the next phase of negotiating the technical details. At least the uncertainty of whether to come out of Europe or reverse Brexit and staying in is lifted. On that outcome GBPUSD will probably push through resistance at 1.3380 the March 2019 highs quite easily. Above that, the next target will be 1.3470 which matches with the 61.8 Fibonacci retracements. Then 1.3750 comes to attention.
First bearish followed by a possible bullish scenario:
A less likely scenario, but quite possible, is a minority government led by Labour and supported by Scottish National Party and /or Liberal Democrats. Regardless of how that coalition would look like in the end, it will probably lead to a second referendum. The UK and EU will restart negotiations and the leave camp will face even more hurdles to win it again let alone deliver it. The renewed uncertainty will probably trigger a selloff. The support at 1.30 will be the next target followed by 1.2860. However, once a second referendum becomes the only solution, a slight recovery could be on the cards. So, expect a downtrend (hard to tell how steep) first, followed by a possible relief rally.
Really bearish scenario:
A majority Labour government is the least likely but should be considered given the radical manifesto promised by Jeremy Corbyn&Co which some voters might find appealing. Labour targeted the business owners vowing to impose tax hikes, nationalise utilities, transport, post offices and part of the telecom industry. And for every £1 promised by Tories, Labour would spend an eye-watering £28. So we might expect an outlier result, either a shocking turnaround or a spectacular failure. Capital Economics looked at history and said a left-wing victory in France in 1981 led to a 15% fall in French equities. A sharp selloff in GBPUSD would be the most probable outcome. It would not be a surprise to see GBPUSD retesting the lows of 1.1957, touched in September 2019, in rather quick time.