The pound soared, gilts fell and British stocks surged after Prime Minister Boris Johnson’s Conservative Party won a majority in the UK general election, raising hopes that an end to the Brexit deadlock will unlock pent-up investment flows.
Sterling at one point was on course for its biggest gain against the dollar since April 2017, though the moves eased a little during European trading hours. The currency touched the strongest level versus the euro since just after the 2016 Brexit vote. UK government bond yields jumped at the open as traders also slashed the odds of a rate cut in the coming year.
Johnson’s decisive victory diminished a risk that has weighed on the pound for more than a year. The Conservative Party’s win allows him to push his Brexit deal through Parliament and start negotiating a trade deal with the European Union. It could also end the parliamentary gridlock that has held back investment and contributed to an economic slowdown.
“To me this signals that the worst of Europe’s malaise is behind us,” said Jack McIntyre, a portfolio manager at Brandywine Global Investment Management in Philadelphia. “The results take away a key risk in markets, and while there are still issues with US-China trade, this UK election is one of the big ones. Long sterling is our biggest currency position outright.” The firm has a target of $1.50.
Sterling pared its advance of as much as 2.7% to trade 1.9% higher at $1.3412 as of 8:18 a.m. in London. It rallied 1.5% against Europe’s common currency to 83.18 pence per euro, touching 83.34 pence, the highest level since April 2017.
The news also rippled through to other assets with the euro touching a four-month high against the dollar.
In the stock market, the benchmark FTSE 100 Index jumped 0.9% even though the stronger currency weighs on the income of exporters who dominate the gauge. The more domestically-focused FTSE 250 Index rallied 4.5%, the most since 2010.
Investors favour the prospect of a market-friendly Conservative government that can push through a Brexit accord, with Johnson promising all of his lawmakers will back his deal. They were skeptical of Labour leader Jeremy Corbyn’s plans to overhaul the economy through increased spending and nationalizing key industries. Corbyn said he will stand down as leader of the Labour Party after a debate over the left-wing party’s future.
A Brexit deal would also remove a key risk factor hanging over global markets. It follows President Donald Trump’s backing for an initial trade deal with China and a clearer outlook for monetary policy at the Federal Reserve and the European Central Bank after their December meetings. Global stocks are trading at a record high and investors are moving out of havens including government bonds and the Japanese yen.
The yield on 10-year German government bonds jumped four basis points at to minus 0.226%. Benchmark gilt yields added six basis points to 0.876%.
Time to reposition
With Brexit uncertainty and a minority government leading to turmoil, some investors have been opting to stay on the sidelines. This suggests there’s scope for further gains in the pound and UK stocks, according to Amundi Asset Management.
“We should bear in mind that foreign investors were massively underweight UK equities since 2016 and short sterling,” said Didier Borowski, head of macroeconomics at Amundi. “They will re-position themselves, at least partially.”
Fritz Louw, a strategist at MUFG Bank Ltd, sees the pound heading for $1.36-$1.37, while Morgan Stanley strategists say it could rise to as high as $1.40 if it breaks through resistance at $1.34.
Traders are already looking ahead to a quiet Christmas after a year fraught with political risk. A gauge of volatility for the pound over the next six months has fallen to the lowest level since January 2018 as markets foresee a brief respite before the negotiations over a final trade relationship with the EU begin.
Though a Conservative majority is seen as the most market-friendly outcome, not everyone expects it to lead to a sustained sterling rally. The trade talks could prove even more complicated than the process of negotiating Britain’s exit from the bloc, raising the risk of fresh market volatility down the line.
“A strong majority means the withdrawal bill gets through in January,” said Jeremy Stretch, head of Group-of-10 currency strategy at Canadian Imperial Bank of Commerce. “I would still be wary of chasing the pound higher at these levels though.”