GBP: Worst-case outcome adds to Brexit risk premium – Danske Bank

The UK election outcome looks close to the worst possible for sterling – if any winner, it may be regarded the EU according to the analysts at Danske Bank.

Key Quotes

“The prospect of a hung UK parliament based on the first exit poll initially led EUR/GBP to jump above the 0.88 level last night but the knee-jerk reaction has been moderated a bit with the possibility of a Tory-led government that may just about get a slim majority and the cross is trading around 0.8780 at the time of writing.”

“What matters for sterling near term is the strength of the government that goes to Brussels to negotiate Brexit terms on behalf of the UK – and with any possible governing coalition set to be weak, so will GBP be. There is clearly a risk of EUR/GBP breaking above 0.88 again if the Tories fall short of even a slim majority. Notably, speculators covered GBP shorts ahead of the election, suggesting room for speculative GBP selling near term. What matters for the sterling longer term are the Brexit terms – and the prospect for these have not become more favourable following the present election result as negotiation power has essentially shifted from the UK to the EU. However, if the new government adopts a softer Brexit approach it may be GBP positive later on, but it is obviously very speculative at this point.”

“Our Brexit-corrected medium-term valuation (MEVA) model estimate for EUR/GBP is around 0.83, which notably suggests that even when Brexit uncertainty is out of the way, GBP is not necessarily set for large-scale appreciation. But it remains too early to judge e.g. the implications for trade terms from this election outcome.”

“On top of the ‘Brexit uncertainty premium’, which has been haunting GBP markets since June last year, a form of ‘government risk premium’ has now been introduced for the very short term as well: almost irrespective of what government is formed, the UK will not be heading for Brexit negotiations with any great sense of confidence based on the election result as it stands at present, and this will weigh on the pound. We see EUR/GBP in the 0.84-0.90 range near term.”

“A wildcard for GBP would be a new election: while this would introduce continued uncertainty for the short term, it would also open up the option of a majority government after voters had their say again, and possibly be GBP positive eventually that way around.”