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Snap elections in the UK - what could GBP do?

When an announcement came from the British prime minister’s office that she would have something important to say on Tuesday morning, the market started to prepare for a GBP-negative news, not really knowing what could come out of the speech.

It seemed most hot topics were closed – the Brexit bill passed Parliament without much friction and the formal act of triggering Article 50 had already taken place, so no new high-level announcements were expected at this point in terms of the UK leaving the EU. 

The announcement was big - the UK is going to have snap elections on 8-Jun. The market was totally unprepared for this. Downing Street strongly ruled out such an option only a month ago and Theresa May expressed on many occasions over the past year this is not a goal she wanted to pursue. Apparently, she has changed her mind. 

What’s Theresa May’s plan?

This is a gamble to take advantage of the most favourable polls in years for the Conservatives and have a stronger hand when entering the negotiations. There were some doubts if the current relatively thin majority she holds in the House of Commons will be enough for the legislative work needed during the Brexit process (like the Great Repeal Act to restore the original British law).

The decision to leave the EU seems irreversible now and if May plays it right she could get additional support from people that would not vote for her party in any other circumstances. The reasoning is simple - there is no point expressing disapproval for the Brexit at this stage, but giving May more power now might let her get a better deal out of the negotiations.

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YouGov polls show the largest advantage of the Conservatives (white line in the top panel) vs. the Labour Party (yellow) in 8 years and stable lead vs. Liberal Democrats (green); the bottom panel shows the differences of support levels; snap elections could really tilt the composition of the House - check the support prevailing before the 2015 elections; source: Bloomberg

Most of the polls indicate her move comes at the right time, as the Labour Party is losing ground and the Conservatives were, so far, the party to benefit from this.

Wouldn’t this move make the negotiations more difficult operationally?

The UK-EU negotiations of the terms of Brexit and future cooperation could most likely start in the summer (theoretically sooner) and the EU side still needs to formally endorse the guidelines for negotiations and appoint the European Commission, the body that will represent the bloc. This should happen during the summit on 29-Apr. With the prospect of general elections the EU would most likely also prefer to wait for the new formal UK representatives instead of starting the talks with some that could be gone after the elections.

Can the PM simply call snap elections?

No. The Fixed-Term Parliaments Act (2011) allows the government to trigger elections only after a lost no-confidence vote or when two-thirds of MPs agree. For now it seems this won’t be a limiting factor for her plan. The Labour Party agreed to vote for it and it seems she could orchestrate a no-confidence vote anyway.

Local elections

There will be local elections on 4-May with seats in around 100 councils and mayor positions up for election. This could be a test if the PM’s strategy is working and she can unite the nation in the face of Brexit negotiations.

What about GBP?

The valuation of the pound remains historically very low so a higher chance of getting a good Brexit deal could be enough to significantly lift it. With stronger parliamentary backing the PM’s ‘threats’ during the negotiations (for example a big corporate tax reduction) could be seen as more credible.

The positioning on the pound seems perfectly prepared for a rebound. There is a historical abundance of speculative GBP shorts, while the size of long positions is close to the lows seen in the last 3 years. Net positioning has recently been even more negative than after the Brexit referendum so a GBP-positive event could really unlock its potential.

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 Speculative net positioning has recently been extreme low which could amplify GBP gains; source: Bloomberg, XTB Research

On the other hand the yield differentials between the UK and the US suggest the pound is already reaching too high. This signal should be treated with caution however as the link between the USD and its yields could have been modified due to geopolitics and the somewhat different approach of the Fed recently.

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US yields have seen quite a pullback which makes it easier why the indication for the cable is negative; issues like Fed’s balance sheet discussion and increased safe-haven demand for US Treasuries have most likely disrupted the relation of the interest rate and fx markets so the indications of the former should be treated with caution; source: Bloomberg, XTB Research

There’s a crucial political risk event for the euro this Sunday - the French presidential elections which could naturally soften the single currency. It also looks technically like a good candidate against which one could seek GBP gains.

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EURGBP may have just found the right news to help it cross the support area; this could open the road to even 0.83, which is where the initial reaction to the Brexit vote ended; source: xStation5

GBPUSD has already broken above 1.27 and it seems to have enough positive momentum to rise above the top of the range present since October. The initial Brexit reaction reached 1.3250 which could become a reference level if the move continues.

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GBPUSD seems ready to abandon the range inside which it traded since October. source: xStation5

One thing to note is that there is also a macroeconomic event that could require some GBP reaction. Retail sales for March will be released on Friday and are now a key release when it comes to the stance of Bank of England.

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