by NGOC ANH 10/07/2024, 11:55

Will the pound rise as a result of the change in government?

Sterling has hardly moved since the opposition Labour Party won a huge 174-seat majority last Thursday. That’s not surprising given that a strong outcome for Labour was expected and the fact that delivering stronger economic growth – and perhaps a stronger pound – is much harder than promising it.

Britain’s Labour Party leader Keir Starmer delivers a speech during a victory rally at the Tate Modern in London early on July 5, 2024.Justin Tallis—AFP/Getty Images

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Nonetheless, the Standard Bank still believes that the pound’s prospects will improve as a result of the change in government. Given time, it would expect the pound to rise to over 1.40 against the US dollar, and it sees the euro/sterling heading down towards 80 cents.

If you look at how the pound has traded since the Conservatives initially won power in May 2010, you will see that the first parliamentary term through to 2015, which was shared with the Liberal Democrats, saw the pound register good gains, in excess of 10% on a trade-weighted basis. The rise unwound much of the collapse that had occurred in the last throws of the prior Labour administration when the global financial crisis struck down the pound.

On reflection, it looks as if that transition from Labour to Conservative/Liberal did mark a sea change in the pound as it went from weakness to strength, but, importantly, this strength did not come straight away. The 2015 election also led to a sea change for the pound, but this time in the opposite direction, as sterling slumped soon after a referendum on EU membership was promised at the 2015 election and then delivered in 2016. Over this period, the pound collapsed by over 20% in trade-weighted terms. Since that slump in 2016 the pound has basically flatlined.

In short, the step down we saw because of the Brexit referendum has endured; there’s been no step back up. Could that change with the introduction of the Labour Party? It seems clear from the last decade that Brexit seems to be the key. As we said, sterling slumped after the decision to leave the EU and has not recovered since. It could rebound dramatically if Labour were to call a new referendum on Brexit, but it is not going to do that.

However, this does not rule out the possibility that the Brexit pain will diminish and sterling will rise in its slipstream. For a start, the new trading environment takes some time to settle down. In the early phase of the agreement the Brexit decision hits the UK hard as the damage to trade with EU countries comes before any help from new trade deals with other countries.

Hence, there might be a more ‘natural’ improvement in trade – and the pound – in coming years which would have been in place whoever won last week’s election. But on top of this Labour is seeking to soften the Brexit blow. This will likely require concessions to get a deal with the EU, if any deal can be done at all. But this might still make traders and investors look a little more favourably on the pound.

Another point is that Labour is likely to be less vulnerable to the internal Party squabbles that we saw from the Conservatives that led to miss-steps and sterling weakness, like the Brexit referendum and, more recently, the disastrous September 2022 mini-budget.

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Of course, we can’t totally exclude the possibility of damaging in-fighting within the Labour government just as we cannot exclude the possibility of another large external shock such as Covid and the war in Ukraine which damaged the economy and the pound under the Conservative’s watch. Another caveat, which could mimic the experience of the Conservatives after the Party first won power in 2010, is that it takes some time for a new government to put a positive mark on the currency.

We see the same situation for Labour now for, as the new Chancellor Rachel Reeves admitted yesterday, Labour is picking up an economic baton from the Conservatives which is more like a poisoned chalice. Hence, barring a quick volte-face on holding a second Brexit referendum, which appears impossible, sterling is not going to ‘step up’ in rapid fashion.

Instead, even if the new government can revive the economy, put Brexit on a better footing, and avoid any of the self-inflicted damage we saw under the Conservatives, the rise in the pound will likely be quite slow, relatively smooth – and require some patience.