How quickly does pound stress build up?

The British Prime Minister Rishi Sunak is lagging far behind in the polls. Yet he called for elections last week. However, this unexpected move does not lead to unrest in currency markets. In fact, the pound rose to its highest level since 2022.

Political uncertainty has had a significant impact on the pound's direction over the past decade. The Brexit referendum of June 2016 is the best example of this. When it was announced that a narrow majority of the British people favored leaving the European Union, the pound fell by more than 10 percent within a few days.

And even during the negotiations for the UK's withdrawal, the exchange rate sometimes fluctuated by percentages. The surprising announcement by Prime Minister Rishi Sunak that the House of Commons elections will take place on July 4 seemed to be the prelude to a new swing in the exchange rate. However, instead, it remains remarkably calm on the currency front.

Outcome seems already determined
One of the main reasons why the pound hardly moves is because the outcome is actually already determined. The opposition party Labour has a lead of as much as 20 points in the polls. Many Britons blame the ruling Conservative Party for the high inflation in 2022 and 2023. The prices of food and electricity have risen by more than a quarter in recent years. Although inflation is clearly decreasing and the government has spent heavily on energy subsidies, this is hardly reflected in the polls. Currency traders have been able to position themselves for a Labour election victory for months. The fact that the election is taking place a bit earlier than expected does not change that.

All eyes on the Bank of England
Furthermore, the policy of the Bank of England (BoE) currently has much more influence on the pound's movement than the upcoming elections. The inflation in the British services sector in April was significantly higher than economists had expected. For the central bank, it is still too early to adjust the policy rate. The European Central Bank has been preparing for a rate cut in June for a while. Given the recent inflation figure, it is likely that the BoE will hold off. A growing interest rate differential works in favor of the pound. The interest rate tailwind also explains why the pound has already risen by 3% against the euro since November. Last week, the pound even reached its highest level since the summer of 2022.

Smart time to hedge risks
Of course, it is by no means certain that the calm in currency markets will continue until the elections. For example, due to some missteps by Theresa May, the Conservative Party unexpectedly lost its absolute majority in the 2017 elections. It will be exciting in the coming weeks to see with which party program the Labour Party will enter the election race. However, for all companies doing business in the UK, the currency calm currently offers an excellent opportunity to hedge exchange rate differences at an attractive price. Because experience shows that this protection becomes much more expensive when tension around the pound starts to rise again.

Joost Derks

Joost Derks is a currency specialist at iBanFirst with over twenty years of experience in the foreign exchange market. This column reflects his personal opinion and is not intended as professional (investment) advice.

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