Thursday / June 20.
HomeMarketsWhy Theresa May spurred a bounce in the pound

Why Theresa May spurred a bounce in the pound

Before she spoke on Tuesday, Theresa May was gaining a reputation for talking sterling lower by spooking investors that Britain was headed to a disorganised exit from both the EU and its common market.

Her Lancaster House speech was the first occasion the pound rallied to her Brexit views since becoming prime minister; it had risen nearly 3 per cent by the end of the London trading day, nearly touching $1.24, and placing the currency on course for its best one-day gain since October 2008.

The pound’s strong jump may appear incongruous. After all, for much of the last three months, sterling has fallen every time Mrs May has made it clear Britain was headed out of the single market. On Tuesday, the prime minister confirmed that was her intention — and yet the currency rose.

Why did the market like her speech?

Clarity. As much as they felt nervous over exit from the single market, investors were frustrated by the prime minister’s opaqueness, as demonstrated in sterling’s sharp fall earlier this month following an interview on Sky News.

The market has clung to the idea that a “soft Brexit” could still be in her thinking — exiting while retaining privileged access to the single market. But her statements ruled out that course and made clear she was intent on freeing Britain from the jurisdiction of the European Court of Justice. That would allow the UK to end free movement of EU citizens into Britain.

She also said she would not seek an “off-the-shelf” trading model copied from other countries. All that has, at the very least, removed the ambiguity of where she stands.

Markets have been negative on a hard Brexit, so why the sterling rally?

Some analysts were surprised by the reaction. “If you had told me this is what would have been said before the speech, I would have argued it should not really see a sterling rally of the size we have seen,” said Nomura forex strategist Jordan Rochester.

But this reaction was similar to how investors responded to Donald Trump’s victory speech on November 9: it was conciliatory towards Europe, vowing she had no interest in seeing the EU unravel. “In other words, markets like certainty, and sterling is welcoming the clarity around the ‘hard Brexit’ path,” Mr Rochester says.

Sterling’s rally followed sharp falls generated by pre-speech expectations and weekend reports of much of its content. The subsequent rally during her speech smacks to some as classic “sell the rumour, buy the fact” market behaviour.

As Simon Derrick at BNY Mellon says: “The advance notice of much of the speech did much to take the sting out of the news that the UK is leaving the single market and customs union.”

In addition to detecting a conciliatory tone in Mrs May’s speech, analysts saw specific passages they believed supported sterling, notably her wish for transitional arrangements and an assurance that a final Brexit deal would be subject to a vote of both houses of parliament.

The promised vote “appeared to offer some degree of assurance that the deal would have a broad appeal”, says Jane Foley, foreign exchange strategist at Rabobank. “That said, it also provides another element of confusion should the deal not be passed by parliament.”

What else may be influencing sterling movements?

Dollar weakness has been the other currency trend of the past few trading days, particularly after Mr Trump said its strength was harming US corporate competitiveness. Its sell-off has boosted the pound.

A Monday night speech by Mark Carney, where the Bank of England governor singled he was worried about rising inflation, also helped, since any move by Mr Carney to raise official interest rates would strengthen the currency. That sentiment was bolstered by higher than expected inflation data published on Tuesday morning.

Where next for sterling?

The pound’s rally means it is approaching its 50-day moving average of $1.2413; if reached, that level could set a floor for sterling traders.

The Supreme Court’s upcoming Article 50 ruling on whether the government needs to give parliament a say on triggering the formal two-year divorce process could prompt a further rally. Politics will continue to influence sterling, but so will data on whether the post-Brexit resilience in the economy holds.

“The risks are still that sterling goes lower,” says Kamal Sharma at Bank of America Merrill Lynch, adding that the triggering of Article 50 “crystallises the risk”.

Investors will need to keep a sharp eye on European developments, notably forthcoming elections in France and the Netherlands when established parties will be challenged by the rise of populist movements. That could help “to ease downward pressure on the pound in the coming months”, says Lee Hardman at MUFG.

“It supports our view that the pound could be close to bottoming in the near term, especially against the euro,” he says.

What are the big questions for investors?

Whatever clarity Mrs May provided, investors remain bearish on the pound, worried about the economic consequences of Brexit and the potential negative impact on inward investment. “Ultimately, the issue is still how effectively the UK can deal with its large current account deficit,” says Mr Derrick.

The speech will inevitably start to be unpicked by Mrs May’s detractors, while reaction from the EU will also weigh on sterling.

In time, says Mr Rochester, the May speech presents investors with a UK Brexit objective that is “the least market-friendly in the long run”.

Source link