ETF Securities Research Blog

GBP to gain after the UK election

We expect that the British Pound will gain after a period of consolidation around current levels ahead of the UK election next week. The latest polling indicates that Prime Minister May’s lead has declined, prompting a modest pullback in the local currency. We expect that although GBP could soften further in the coming week, as the Conservative party’s lead see-saws, but believe it will stay above key support of 200-dma, which is currently 1.2595.

While we expect a Conservative election win, the future EU negotiations remain an important driver of GBP direction. We continue to believe that the worst case scenario has already been priced in regarding the Brexit negotiations and its impact on the economy and the financial services sector in particular. In coming years, a rising rate environment and further clarity surrounding the EU-UK negotiations should be reflected in rising banking sector valuations.

gbp and banks

Investor positioning has begun to rebound from the lowest levels on record in the futures market, indicating that there is growing optimism for the UK’s economic prospects as ‘Brexit’ negotiations begin. Although still in negative territory, GBP net shorts have more than halved since the record pessimistic positions seen at the end of March 2017. In contrast, Euro positioning is at the highest level since November 2013, and any further dovish comments from ECB Board members, could prompt a sharp decline in EUR/GBP in coming weeks.

Investors have become more positive on the outlook for GBP because the domestic economic environment has remained resilient. Nonetheless, the Bank of England expects some softer numbers from the household sector as wage growth has been revised down at the same time that inflation is rising.

With headline inflation expected to peak near current levels, we believe that real rates are forming a bottom. Accordingly, GBP has responded in line with the modest rebound in real yields and we expect the gradual move higher in yields to continue. Not only do we expect the Bank of England to reverse the Brexit-induced rate cut of last year, but inflationary pressures are expected to moderate as the impact of the exchange rate plunge on prices begins to fade.

After the UK election next week, as FX volatility continues to moderate, GBP could again test the 1.30 level and potentially break to the upside as the domestic economy remains resilient, targeting 1.35.