Low Sterling Confidence

Discussion and Analysis by Charles Porter:

A couple of months ago, the cloud looming over the United Kingdom’s political economy appeared to have receded, if only to show a lighter shade of grey. Following Theresa May’s Florence speech and the warm reception that it received from European officials, the Pound Sterling received a highly illusive tailwind. However, following a ‘dovish’ Bank of England hike in the interest rate and an unstable domestic polity, confidence in the Pound Sterling has once again dropped. Opening around 1% weaker against the US Dollar this morning, the threat of a vote of no confidence in Theresa May’s leadership held the Pound behind.

The Sunday Times reported yesterday that as many as 40 British MPs had agreed to sign a letter signalling their discontent in Theresa May, threatening to culminate in a vote of no confidence. Should the vote manifest and dissatisfaction with May’s leadership grow within the Commons, then the UK’s political bedrock would be brought into tumult. Politics truly matters when it comes to financial markets and exchange rates because the political system not only determines the regulatory backdrop of the economy but also, to a significant extent, determines its stability and prosperity.

The British Parliamentary system implies that should Theresa May face a vote of no confidence, it is highly likely that the opposing party would enter power. This is because a successful vote would trigger a General Election where the opposition party currently holds higher public opinion than the incumbent. A Labour government under the leadership of Jeremy Corbyn MP has been framed as highly unfavourable to both the budget deficit and Brexit progress.

Evaluating the accuracy of this claim requires personal political preferences to be suspended. The facts would suggest that the policy preferences of Corbyn and the Labour Party would require greater government spending and, in the face of highly static budgetary revenues, would be particularly likely to add to a significant deficit and level of borrowing.

Moreover, upon the triggering of Article 50 in March of this year, the incumbent government has nurtured its position on Brexit and made considerable developments in the negotiations. Despite the arguable lack of success within the 6 rounds of negotiation to date, it is inconceivable that at least the slightest headway has not been made.

Negotiating the UK’s Secession from the European Union is arguably one of, if not the, most important political responsibilities that the UK will face for a long time. It should not be forgotten that the Secretary of State for Exiting the European Union is a politically accountable and elected MP; David Davis. Therefore, unlike a technocratic and independent institution, a leadership election that turns into yet another General Election could well result in the replacement of Davis.

Moreover, given the propensity for an opposing party to dig up and dispose of the current foundations that negotiations have produced, a vote of no confidence is sure to take up considerable time in what is already an incredibly finite period of two years under the Lisbon Treaty.

The salience of a vote of no confidence should therefore not be understated. Although I do not expect the message to be heeded, politics should not be something that Westminster jokes around with right now. So how credible or necessary is the vote of no confidence in Theresa May? Well, the instability within her Cabinet has been significant. The low standing status of some pivotal members that still remain, namely Foreign Secretary Boris Johnson and First Secretary of State Damian Green, is highly troublesome for any longevity in May’s leadership. On top of this, two senior cabinet ministers, Priti Patel and Sir Michael Fallon, have faced such pressure as to resign in recent weeks.

It is unsurprising, therefore, that the Pound reacted violently to the weekend’s news. At times today, the Pound lost in excess of 1% against the US Dollar, with a slightly weaker Euro moderating the losses within the EURGBP currency cross. Throughout the afternoon, because the situation did not mature greatly, the Pound gained some of this ground back, at times, to the order of 50%. In a data-heavy week, the Pound still appears most vulnerable to politics, even in the face of CPI inflation on Tuesday.

Theresa May will be speaking at the Lord Mayor’s Banquet this evening. Her comments there will be an opportunity to gauge how she will handle the threat that exists to her leadership. Ridding the political instability that has plagued the Pound amidst Brexit will be critical to achieving value within Sterling markets once again.

Click Here to Subscribe to the SGM-FX Daily Newsletter