What’s best for a currency?

>> Political stability to aid sterling

The left-right debate about the best government for a currency is probably a bit archaic and, in fact, may not be true anyway. In the US, for instance, Democratic presidents have usually seen the dollar rise, and Republicans fall. In the UK, the biggest policy-induced collapses in the pound in recent decades have happened under the watch of the Conservatives (the Brexit referendum of 2016 and the pullout from the Exchange Rate Mechanism in 1992).

Moreover, these days, it seems that right-leaning parties are often thought of as the most extremist, especially when it comes to the key topic of most developed-country elections at the moment; immigration. Nonetheless, there’s still a sense, at least in the UK, that a Conservative government is more likely to follow policies that lift the pound than the Labour Party. But the problem is that the Conservative government has been inherently unstable since the Brexit referendum in June 2016.

This instability was best highlighted during the disastrous 44-day Liz Truss leadership in 2022 when, seemingly business-friendly policies in the mini-budget had to be rapidly unwound because of market pressure. This instability creates a poor environment for investment, growth – and the pound. Private sector investment in the UK accounts for around 10% of GDP; lower than any other G7 country with the best being closer to 20%. Now clearly, political instability cannot be blamed for all of this weakness, with issues such as Brexit being a factor as well as a generally rising tax burden, COVID, and much more.

Nonetheless, we put some of this investment underperformance down to political instability under the Conservative government. The weakness in investment likely explains the UK’s poor productivity performance as well, where output per hour is down by around 20% from the trend that we saw before the Conservatives won office in 2010.

Steve Barrow, Head of Standard Bank G10 Strategy, said poor productivity performance over time usually spells poor currency performance given that productivity is the most fundamental indicator of a country’s health. The result is that any benefit to the economy and the pound from the more right-leaning, business friendly, policies of the Conservative government has been usurped by the political instability that has dogged the party for some years.

The question now is not whether the UK is veering towards a less business-friendly environment under a Labour government, but whether the country is about to move from instability to stability. Steve Barrow suspects that it is, and, if this proves positive in terms of the UK’s relative investment and productivity story, then it should be positive for the pound as well, not least because this instability seems to be one factor that has led to reticence amongst foreign investors as reflected, for instance, in the underperformance of the UK stock market.

In addition, there could be progress under Labour to unwind some of the instability created by the Conservatives by forging closer ties with the EU. Now quite clearly, Labour will not hold a referendum on re-joining the EU, at least in the upcoming parliament, but we would not rule it out in the long haul if the Party stays in power for two or three terms, as seems very likely in Steve Barrow’s view.

“We are not suggesting for one moment that a Labour government is going to be like flicking on a light switch for investment, the economy, or the pound. Change will take considerable time. Nonetheless, we do see the prospects of a Labour government on Thursday as likely to usher in a stronger pound in the long haul with a rise up to the 1.40 region against the dollar while euro/sterling treks slowly down to the 0.90 level in the coming years," said Steve Barrow.