Sterling drops after yesterday's rally


In a novel change for markets, this morning’s political developments have seen sterling climb up a cliff instead of falling off one. The pound shot higher by more than 2.5% in minutes last night after official exit polls showed the Conservative party with a commanding majority. As actual constituency results confirmed that yesterday’s general election was a historic victory for the Conservative party, the pound did not make any further progress, and in fact pared back its progress slightly, falling by about half a percentage point from the highs seen after last night’s exit poll. The size of the Conservative majority has important implications for Brexit. Boris Johnson now has a wealth of options for dealing with the EU, but the trajectory of trade talks remains a major unknown factor for sterling at the moment. With a stronger hand for dealing with eurosceptic hardliners, Johnson is in a position to offer concessions for a free trade deal, such as the border in the Irish Sea that enabled his withdrawal agreement breakthrough. But a strong majority could prove a double-edged sword for sterling as the new Government could decide its majority means it has a strong hand for hardball tactics with the EU. How the economy responds to the changed political dynamic will determine how far sterling’s relief rally can extend, particularly the extent to which business investment recovers. In the short run, the most important question seems to be what direction the newly ascendant Boris Johnson will wish to take the Government.


Yesterday’s ECB meeting was a breath of fresh air as newly appointed governor, Christine Lagarde, walked both markets and journalists through her communication style. The former IMF head told spectators to not read too much into the choice of wording used to predict monetary policy, a theme that was prominent under Draghi’s tenure. The meeting itself didn’t change too much in the broad scheme of things, but volatility did re-enter the currency pair. The euro rallied as Lagarde noted that the Asset Purchasing Programme would be the marginal policy instrument, ending before rates were adjusted. Overnight, the euro was dragged higher as trade risks subsided. A strong majority captured by the Conservative party in the UK general election looks to have finally given Brexit the green, moving negotiations onto the trade deal, while headlines seemingly suggest the US and China are set to avoid Sunday’s tariff increase as the phase one deal floated over the last week has been signed off by President Trump. The euro rallied 0.36% overnight on the renewed trade optimism, which comes just as the currency area’s survey data begins to show signs of turning. For now, the optimism is likely capped in the single currency despite ECB speakers scheduled throughout the day.


The dollar softened overnight as headlines came in that Donald Trump has signed off on a phase one trade deal with China, leading to the tariff increases on Sunday being postponed and reducing risk in global markets. The G10 broadly sits higher against the greenback, with the Japanese yen the only currency in the red as risk-off flows unwind somewhat. The onshore Chinese yuan fell back below 7.00, but markets are still sceptical that the deal is yet to be formally announced and that a narrow trade deal is not a foregone conclusion. While easing trade tensions between the US and China is beneficial for the US economy, the positive externalities to market sentiment and global growth have put pressure on the dollar today.