Pound Investors’ Biggest Fear on Snap U.K. Election Isn’t Jeremy Corbyn

(Bloomberg) --

Pound traders eyeing a snap U.K. election in December are more worried about Brexit champion Nigel Farage than the socialist agenda of Labour leader Jeremy Corbyn.

Faced with a vote as much about Brexit as the contenders, making it more difficult to predict, Goldman Sachs Group Inc. and BlueBay Asset Management have backed away from bets on pound strength. Sterling is set for a rally of more than 5% this month, its best performance in over a decade, but strategists now expect the uncertainty to prevent it gaining further.

The main risk for them is not the vision for higher taxes and nationalization touted by Corbyn, but Farage’s Brexit Party and its ability to influence Britain’s divorce and future relationship with the European Union. The ruling Conservatives led by Boris Johnson have previously ruled out entering a pact with Farage, but they could be forced to turn to him for votes if they don’t get enough support to deliver their Brexit deal alone.

“The worst-case scenario would be anything that increases the possibility of a no-deal Brexit, so one in which the Brexit Party did much better than expected,” said Jane Foley, the head of currency strategy at Rabobank, the top forecaster for major exchange rates in Bloomberg’s latest rankings.

Even though polls show Labour trailing and a Conservative win as the most likely outcome, options show investors are still betting on pound losses heading into the Dec. 12 vote. The pound gained Thursday following a Telegraph report that suggested Farage’s Brexit Party may stand aside in certain areas, raising the chances of a Conservative majority.

Here’s a selection of views on the various scenarios for markets:

Worst Case: Brexit Party Coalition

• For Rabobank’s Foley, if the Brexit party forms a large part of a coalition with the Conservatives, “that would mean the trade negotiations next year would be quite difficult and that the risk that we crash out of the EU at the end of the transition phase would increase.” That could make the pound vulnerable to a fall toward $1.20, with a further slide to $1.15-$1.10 if no-deal really begins to look likely.
• Mark Dowding, chief investment officer at BlueBay, also thinks the Brexit party doing well is the worst outcome but says “there’s no way I can see that happening.”
• “Continued uncertainty is probably the worst outcome as it is clear that the uncertainty itself is undermining the economy,” said Russell Silberston, a fund manager at Investec Asset Management, which oversees $145 billion. That would result from a hung Parliament in which no party has an outright majority.

Base Case: Johnson Wins, Brexit Deal

• “Our central view is we probably assume that Johnson does manage to cobble together a government and he gets the deal through,” said Rabobank’s Foley, who expects the currency could rally 2% to $1.32 on this scenario before trade talks with the EU again cap sterling strength.
• “In an election, the Tories are widely expected to win and implement the Johnson deal,” said BlueBay’s Dowding. “If they fail to win, they will still most probably be the biggest party in Westminster and we could have a referendum on the Johnson deal or no Brexit altogether.’’

Best Case: No Brexit

• “The best case is no Brexit and no hard-left economic agenda,” said Investec’s Silberston.
  • Silberston sees Johnson’s Brexit deal as priced in by markets, so if the Conservatives win “we should see a bounce in anticipation of a stronger recovery” but if the anti-Brexit Liberal Democrat party does well it may result in no Brexit at all and “this will lead to much more upside to sterling.”
• “A surprise Labour win could see the pound fall in the short term but in coalition we would expect Labour to be more moderate than may be feared, like we saw with Syriza in Greece,” said BlueBay’s Dowding. “Hence weakness in sterling could be short lived and a second referendum and no Brexit could see the pound rally.’’
• Petr Krpata, a strategist at ING Groep NV, also sees a U.K. ruling coalition with Labour as helping to support sterling if it increases the probability of no Brexit.

To contact the reporters on this story: Charlotte Ryan in London at cryan147@bloomberg.net;Anooja Debnath in London at adebnath@bloomberg.net

To contact the editors responsible for this story: Paul Dobson at pdobson2@bloomberg.net, Neil Chatterjee

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