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Pound traders are unlikely to find that the promise of a December U.K. election provides an escape from the Brexit maze.
The currency pared losses after the Labour Party backed government plans for an early poll, before lawmakers vote on the decision later Tuesday. An election is unlikely to send the pound plunging with the Conservatives ahead in the polls, strategists say, yet there is enough uncertainty around the result and the Brexit outcome that it also won’t prompt a huge rally.
“The most severe of the longer-term structural risks facing the U.K. -- a no-deal crash out -- have all but evaporated,” said Ned Rumpeltin, European head of currency strategy at Toronto-Dominion Bank. “There is a lot of good news in the price, and the balance of headlines may not be as constructive once we head into an election cycle.”
The pound is headed for its best month against the dollar since January 2018, with no-deal Brexit risk reduced after lawmakers voted to force Prime Minister Boris Johnson to seek an extension to the deadline. The likely election now looks set to become a proxy vote on European Union membership.
The pound rose 0.1% to $1.2878 on Tuesday, and climbed 0.2% to 86.16 pence per euro. The yield on U.K.10-year government bonds held steady at 0.72%.
Wary Investors
Even as polls suggest a Tory-led government is the most likely outcome, the market will be mindful of risks around Jeremy Corbyn. Investors have long been wary of a government led by the left-wing Labour leader, who is seen nationalizing parts of the economy, boosting borrowing and redistributing income.
There is also the question of how the two main parties position themselves on Brexit. If Labour opts to campaign on a platform of no Brexit or an arrangement where Britain maintains close ties with the EU, while the Conservatives go for a departure at any cost, volatility will likely pick up into the vote, according to Thu Lan Nguyen, a currency strategist at Commerzbank AG (DE:CBKG).
“I wouldn’t expect a large market reaction in pound spot rates,” said Nguyen. “Rather, I think we will see a repricing on options markets, factoring in an increased political risk around the date of the elections.”
Option pricing has been subdued in recent days, with implied volatility in the pound staying low in the shorter and longer term. This suggests traders foresee smaller jumps in the currency, reflecting optimism about the fading risk of no-deal, contained by pessimism caused by simmering political uncertainty.
Persistent question marks over Brexit itself could also keep a lid on the pound. Traders may also shift their attention to the risk of the second phase of Brexit negotiations when Britain will have to decide its future relationship with the EU.
“The capacity for sterling to enjoy a major relief rally that ‘it’s over’ may be more constrained than others may think because, let’s face it, it’s not over,” said Toronto-Dominion’s Rumpeltin. “Not by a long shot.”
(Adds options context, comments from Commerzbank (DE:CBKG), updates pricing.)