Image: Pound Sterling Live.
British pound can experience a period of outperformance as political and fiscal risks are pushed into the Autumn.
The pound can extend gains against the euro and non-dollar currencies over the coming days and weeks amidst delayed political risks and a cautious approach to interest rates at the Bank of England.
The country's next Prime Minister, Andy Burnham, has made it clear he is not rushing to announce new policies or appointments, and it won't be until the back end of July that traders get something to sink their teeth into.
A speech delivered in Manchester on Monday by Burnham gave an upbeat vision for the future, but it was light on detail, allowing markets to quickly lose interest.
If anything, there was a slight positive as the PM-in-waiting did recommit to respecting the fiscal rules, helping ensure the event passed without event.
"Perhaps the most telling thing from a market perspective was Burnham's commitment to the existing fiscal rules. There was no sense of trying to find ways to game the rules or increase borrowing, which would have worried markets," says Jack Meaning, economist at Barclays.
Pound Can Strengthen to New Multi-month Highs, Short-term
With politics proving to be little more than a sideshow for now, the pound continues to follow the path of least resistance higher against the euro and other non-dollar pairs.
The pound-to-euro climbs to 1.1614 at the time of writing on Tuesday, and could be poised to deliver a new multi-month high, before testing the next major resistance at 1.1634.
In sterling's corner is the residual rates advantage conferred by the recent spike in oil and gas prices from the Iran conflict; the UK's bond yields are amongst the most elevated in the G10, and that's attracting currency inflows.
Against the dollar, the outlook is decidedly more subdued owing to the dominance of the USD leg of the trade. Here, U.S. economic outperformance and elevated expectations for a Federal Reserve rate hike will likely maintain pressure to the downside in GBP/USD.
But, There's a Limited Window for Gains
The call from currency strategists we follow is that the pound could come under pressure as uncertainty builds into Burnham's first budget.
"UK resilience may frustrate shorts, but closer to the Autumn budget we expect fiscal risk premium to build," says Meera Chandan, FX strategist at JP Morgan in a recent GBP overview note that touches on current political developments.
He will take over as PM at the end of July and will have a short window before politicians go home for their summer holidays.
The appointment of his cabinet could be the first trial for markets, as there could be some unease over the appointment of a left-leaning Chancellor, most likely Ed Miliband.
"Markets have been unfazed by events so far, but we think many market participants are instinctively wary of Burnham given his previous comments. This means any missteps could see sentiment move against the new government, and Burnham's choice of chancellor will be the first big test," says a note from Oxford Economics.
Above: UK gilt yields (rates) are supporting GBP for now.
When Burnham returns in September, he will find a limited window to position himself for the Autumn budget.
Expect tax and spend ideas to be trailed in this period; it's also when pressure on the pound could start to mount.
Elliott Jordan-Doak, economist at Pantheon Macroeconomics, says the likely next PM has already committed to the fiscal rules, nevertheless we think he will face significant pressure to spend more."
Burnham hinted in his Monday speech of a need for greater spending, saying "while not taking risks with public finances, [I] will seek to give Britain some breathing space [from rising costs]".
"So, we think the risks are that Mr. Burnham will deliver a taxand-spend Budget in the autumn, and tweak the fiscal rules to allow more room to borrow," says Jordan-Doak.
Burnham Will Almost Certainly Bend the Fiscal Rules
The fiscal rules are the single greatest constraint on how much a Prime Minister can borrow.
Under Chancellor Rachel Reeves, a great deal of borrowing will be done in the first years of the current parliamentary term before the belt is tightened towards the end.
That's what governments do: to stay within the confines of the rules, and to keep the bond market on side, they push the difficult decisions into the future.
Robert Colville at the CPS presents this graph showing how the rules are actually ineffectual in delivering discipline, as government after government simply racks up the debt regardless:
"Of course, the savings/debt reductions never come. Either because the Chancellor shifts the time window (Gordon), or they get fired and someone else comes in, and punts the savings even further down the line, or there's some kind of unforeseen crisis," explains Colville.
Someone else is about to come into Downing Street, and as night follows day, the fiscal rules will be altered.
We know Burnham already has esteemed economists Andy Haldane, Richard Hughes and Jim O’Neill, on his side. They will provide the guidance needed to shift the fiscal rules in order to allow Burnham to borrow more.
That's opportunity for Burnham, but it presents risk for financial market confidence.
"Any signs of fiscal profligacy risks renewed fixed income volatility and or an extension in already elevated Sterling short positioning," says Jeremy Stretch at CIBC Capital Markets.
"This autumn’s Budget will be the next landmark. But given the pace at which events have unfolded in recent weeks, it’s unlikely that Burnham’s team has a detailed policy package ready to go. A change of chancellor will add to the time constraints. So we think there’s a good chance that ‘Burnamism’ could be more of a slow burner," says Oxford Economics.