Sterling’s muted reaction to the crisis engulfing Boris Johnson is a sign that the UK’s currency may begin to lose some of its sensitivity to policy changes, investors and analysts say.
The prime minister is facing calls to resign over allegations of blocked Downing Street parties, while lawmakers from his own party plan to remove him from number 10. But the saga has not spread to the financial markets with the pound exceeding the last half. decade has often served as a barometer of political instability – barely hesitant.
Sterling was looking forward to a strong start to the year, backed by the Bank of England, which in December became one of the first major central banks to raise interest rates since the pandemic, and is expected to do so again next month. The currency rose to its strongest level against the euro in nearly two years, while reaching an almost quarterly high of over $ 1.37 per US dollar.
Although the pound has regained some of those gains in the past week, there is little evidence that foreign exchange markets are preparing for a political shock. Option prices show that the premium paid by investors to guard against fluctuations in sterling has fallen sharply since the BoE surprised markets, keeping interest rates on hold in November and close to its lowest level ever .
The situation contrasts with numerous cases since the Brexit referendum in 2016, when this premium – known as implied volatility – rose ahead of Brexit deadlines or unpredictable elections. In October of that year, HSBC analysts said the currency had become “the de facto opposition to the UK government”.
“I haven’t seen much evidence that the sterling has reacted to politics this year,” said Hugo Lancioni, head of currency management at Neuberger Berman. “The variability is extremely low.”
Lancioni believes that the change of prime minister will bring down the pounds in the short term, but says the prospect is difficult for investors to act today.
“Political uncertainty is negative, but what is the right time for the market to focus on that?” Lansioni said. “Very few people are willing to accept bets with so many other factors that drive things up and down.”
According to some analysts, the stakes of the current political dispute are lower economically than the cataclysms of Theresa May’s time as prime minister. When May faced repeated threats to her leadership, for example, the conditions for leaving Britain from the EU were still to be grabbed.
“We will get 1% moves in sterling from Theresa May’s cough,” said Jordan Rochester, a currency strategist at Nomura. “But this is because we knew that if it fell, it would lead to a more difficult Brexit and a potentially very different economic outcome.
“I am not sure this is true today. If we see Liz Trus or Rishi Sunak take power, I don’t think they will take us back to the EU customs union.
Johnson has a form when it comes to moving foreign exchange markets. His decision to support Brexit in February 2016 by making the holiday campaign a popular figure caused a 2 percent drop in the pound, bringing him to a seven-year low against the dollar. The currency fell further after the referendum in June 2016.
Stirling’s failure to recover most of these losses is partly a sign that investors have become accustomed to political instability in the UK over the past half decade, according to Jane Foley, head of currency strategy at Rabobank.
“The fact that we have not restored these levels suggests that investors are used to the political uproar and there is a lot of concern about the post-Brexit environment in terms of price,” Foley said. Trying to profit from Johnson’s precarious position is risky, given that he could be replaced by a less controversial or more pro-business figure who would enjoy the security of a staunch majority of Conservatives in parliament, she claims.
“If we had to go back to a stronger and more stable government, you could actually see a sterling rally from here,” Foley said.
In any case, the attention of investors is elsewhere. Markets are now pricing with four interest rate increases in the UK by the end of 2022, with a chance at a fifth. Investors say the main driver of the pound’s performance will likely be whether BoE is meeting those expectations, not Johnson’s problems.
“Political developments often have a shorter and less impact on markets than economic developments, and we believe that the main factors influencing the pound are BoE behavior, inflation and interest rate changes, and the expectation of a peak Omicron wave.” said Andreas Koenig, head of the global currency at Amundi, which is positioned to weaken the sterling against the dollar.
“These factors will remain in focus and will be much more important than political uncertainty.”