- Analysts are now setting a majority of seats for the Conservatives as their base case, with many projecting that this will offer a sharp boost for U.K. risk assets and the sterling-dollar trade.
- As of Monday afternoon, sterling was trading at just below $1.29, up almost 0.4% during the European trading session.
Sterling will move in accordance with the likelihood of a win for Prime Minister Boris Johnson's Conservative Party at the U.K. general election, analysts are anticipating.
The pound has reacted positively to the Conservatives' growing lead in the polls over the main opposition Labour party, and seemingly balked at the radical economic proposals the latter put forward in its manifesto last week alongside the promise of a confirmatory referendum on Brexit.
Analysts are now setting a majority of seats for the Conservatives as their base case, with many projecting that this will offer a sharp boost for U.K. risk assets and the sterling-dollar trade.
The focal point of Johnson's campaign so far has been the slogan "get Brexit done," and should he succeed at the ballot box, the prime minister will attempt to drive his renegotiated exit deal through Parliament before the extended deadline of January 31.
A Conservative majority and an orderly Brexit at the turn of the year could see the pound trade as high as $1.35, according to UBS U.K. Economist Dean Turner.
"However, further gains are likely to be capped as the next phase of the negotiations ensues. These talks will likely be as drawn out and fractious as their predecessors, and the prospect of the U.K. reverting to a WTO trade relationship with the EU will loom large once again, with the next critical deadline possibly arriving by July 2020," Turner said in a note Monday.
He predicted that in the event of a hung parliament, Article 50, the mechanism triggering negotiations for the U.K.'s departure from the European Union, will likely be extended again, followed by a second referendum. This would keep GBPUSD contained in the 1.25 to 1.30 range, UBS is anticipating.
The likelihood, Turner suggested, is that smaller opposition parties would be inclined to prop up a Labour government but limit its mandate to ensuring a referendum on Brexit, curtailing some of the flagship economic policy initiatives promoted on the campaign trail.
Goldman Sachs analysts have projected that part of the "Brexit discount" on sterling, resulting from uncertainty over future trade barriers and the lingering threat of a "no-deal" scenario, will likely be unwound following the election.
In a note to investors Friday, Goldman Sachs co-Head of Global Foreign Exchange, Zach Pandl, suggested that the increased probability of the U.K. avoiding a no-deal outcome and moving toward a managed transition will facilitate greater inflows into U.K. assets and drive the pound higher. Pandl also suggested that a bipartisan push toward easier fiscal policy should boost U.K. growth in 2020 and ease the relative underperformance since the referendum.
While conscious that Brexit-related uncertainties could linger longer than expected, Goldman has forecast a sharp short-term gain sending cable to $1.35 in three months' time and $1.37 in 12 months.
"The implication is that securing a Brexit deal should reduce uncertainty and unlock some pent up demand for U.K. assets. However, this is only one stage of the process, and signiﬁcant uncertainties will remain around the U.K.'s future trading relationships," Pandl added.
One reason the market is not already rallying in accordance with Conservative polling leads may be that investors are wary of the late bounce Labour enjoyed in 2017.
Conversely, shorts — investors betting against the pound — have actually increased slightly over the last week with a total of around $300 million betting against the currency, according to the latest U.S. Commodities & Futures Trading Commission (CFTC) report.
Indeed, a poll by ICM for Reuters Monday night saw the Conservative lead narrow to 7 points in the last week. Sterling promptly slid 0.2% against the dollar, trading at $1.2872 early on Tuesday.
Nomura FX Strategist Jordan Rochester in a note Monday raised doubts that there will be tradable momentum beyond the "knee jerk" moves to 1.32-1.34 on the back of a Conservative majority, based on Johnson's commitment not to extend the transition period reintroducing the risk of a "hard Brexit" in 2020.
Rochester is long on the euro versus the pound, but admitted that this has become a "pain trade" and suggested that this could be a "make or break week for GBP trades" if Labour fails to eat into the Conservative lead in the polls.
"After this week, if Conservatives continue to poll well then the market may start to price the Conservative majority scenario with more confidence," Rochester said.
"Whilst I pour cold water on this being a big 'Eureka moment' for GBP (given the free trade agreement doubts) it is still likely to be a break above 1.30 towards the 1.32/1.34 range before EU talks begin."
Opinium's latest voter intention poll had the Conservatives at a 19-point advantage over Labour, the widest to date, but this could be too good to be true, according to BMO Capital Markets Head of European FX Strategy Stephen Gallo.
In a note Monday, Gallo suggested that some foreign exchange investors might see an opportunity to buy GBP now on the assumption that the Conservatives win a 25 to 75 seat majority on December 12, but said that from a "reward-for-risk perspective," the outlook for GBP is now incredibly binary.
"We'd much rather be looking for value in selling the GBP on a 1-3 month basis, on the view that hung parliament odds are 'underpriced' by the FX market, and even with a comfortable (Conservative) majority, the remaining U.K.-EU negotiations on an FTA (free trade agreement) will probably raise the odds of a 'no deal' exit from the transition phase in 2020," Gallo said.