Election tension leaves the pound cold

In the United Kingdom, a new House of Commons will be elected tomorrow. Precisely because it is almost certain that Labour will take over from the Conservative Party, it is remarkably quiet around the pound on currency markets.

In recent weeks, the euro's exchange rate has been more influenced by what is happening in European polling stations than by economic developments and the monetary policy of the central bank (ECB). The currency took a hit last month due to the unexpected announcement by Prime Minister Emmanuel Macron of French parliamentary elections. As a result, the euro lost almost 2% against the dollar in June. Meanwhile, the debate between the mumbling American President Joe Biden and his challenger Donald Trump signals a more turbulent exchange rate for the American currency. Before that happens, the British will cast their votes in the House of Commons elections this Thursday.

Political shift
In the run-up to that vote, there is no sign of unrest surrounding the pound. The calm exchange rate is largely due to the political shift that is emerging. It would be very strange if Labour does not secure a majority of the 650 seats in the House of Commons on Thursday. At betting offices, you can only win 2 pence for every pound you bet now on a victory for the center-left party. It would be the first time since 2010 that the United Kingdom has a Labour Prime Minister again. Not so long ago, financial markets held their breath at that prospect. The party has a habit of spending on various government investments that are popular with its base and not being too strict with a decent budget policy.

Painful lesson
Party leader Keir Starmer has seized every opportunity in recent years to emphasize that Labour will implement a very solid policy. The painful lesson from Liz Truss in 2022 is still a good warning of what can happen if he is tempted to increase government spending. With the publication of a preliminary budget that increased the deficit by 2%, Truss at the time risked losing the confidence of the financial world. Bond yields soared and the pound took a significant step back. Calm only returned when Truss withdrew her plans and subsequently resigned as Prime Minister. This was not the first time that the Conservative Party's policies caused turbulence in currency markets.

Finally calm
During the negotiations leading up to Brexit in 2020, the pound sometimes fluctuated so much that traders jokingly referred to it as the British peso. Under the leadership of Rishi Sunak - who replaced Truss as Prime Minister two years ago - the currency has entered much calmer waters. The Labour victory this Thursday will not change that. However, this does not mean that the pound is immune to a change in exchange rates. After the House of Commons elections, attention in currency markets will shift to the interest rate cuts that the Bank of England will implement later this year. If the euro's unrest subsides in the aftermath of the French elections, the pound could easily take a step back towards the autumn.

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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