Should you bet on sterling's election spike?

Ballot papers being counted on May 8 in Redcar, England.
Ian Forsyth - Getty Images
Ballot papers being counted on May 8 in Redcar, England.

The prospect of British Prime Minister David Cameron's party staying in power saw sterling spike nearly 2 percent on Friday, but traders say the rally is unlikely to last after the election shine fades.

The pound breached the key $1.55 level for the first time since February during Asian trade on Friday, well above a five-year low of $1.4653 hit last month, after early exit polls suggested a strong victory for the Conservatives. The results were a surprise to many experts who had anticipated a hung parliament.

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"Sterling has liked the idea of avoiding a protracted period of unworkably weak government," said Kit Juckes, global head of foreign exchange strategy at Societe Generale.

The FTSE market is also likely to see a rally when it comes online on Friday, noted Evan Lucas, market strategist at IG.

But whether the rally can be sustained depends on how strong the coalition will be.

"The prospect for a strong coalition isn't great. Even if the Tories get back in government, the number of seats they hold will be much lower than what it was five years ago, so this could actually be a more fragile coalition," said Nizam Idris, managing director and head of strategy, fixed Income and currencies, at Macquarie. "With the opposition getting seats, that could create more hurdles for the Tories."

Moreover, the threat of a looming 'Brexit' is expected to limit any future upside.

"If the Conservatives do have a successful night as the exit polls suggest, then we're going to head towards a 2017 referendum for a reformed European Union that David Cameron has promised. That is going to bring in a lot of uncertainty," said Heather Conley, director of the Europe Program at the Center for Strategic and International Studies.

Early UK exit polls are 'shocking': Expert
Early UK exit polls are surprising: Expert   

That could see the pound trade range-bound over the next two years following an election spike above $1.55, according to Westpac Bank.

Supporting factors

The election outcome alone won't be enough for the currency to breach $1.55, noted Jonathan Cavenagh, senior FX strategist, Asia, at Westpac.

"A softer greenback and a weak U.S non-farm payrolls figure on Friday will be needed. If the jobs data does disappoint, we could see liquidation in the euro-pound cross, which will see sterling at $1.55," he said.

Judging by forecasts, that's unlikely to happen. Economists polled by Reuters are expecting a creation of 224,000 jobs in April, a significant rise from 126,000 in March.

Meanwhile, Britain's muted macroeconomic fundamentals could also limit sterling's outperformance.

"The economy is doing better, but question marks remain over liftoff from the Bank of England. Similar to the U.S., boosts to wage growth and employment are needed, so the economy is in wait-and-see mode," Cavenagh added.