The FTSE 250, the British stock market that is most sensitive to domestic politics, and the pound, particularly sterling traded against the dollar, have signaled the market’s relief that at least one of the U.K.’s political snarl-ups in the wake of the Brexit vote has been resolved.
In recent weeks, Bank of England governor Mark Carney has exerted more sway over stocks and currencies than Westminster.
It was the governor’s hints that the shock to the UK financial system from the Brexit vote was severe enough to warrant at least interest rate cuts which capped the pound near 30-plus year lows.
We note markets shrugged off revolving doors in the Conservative leadership contest and Labour’s failure to open a trapdoor under its own chief.
It has taken the withdrawal of the last right-leaning Eurosceptic standing, Andrea Leadsom, to raise an unmistakably positive reaction in the City.
The mid-cap index rose as much as 5% on Monday, signally and finally out-doing the multinationals-focused FTSE 100 which has outperformed all major stock markets since 23rd June.
We believe ‘pure-play’ UK equities have rallied on relief that the more pragmatic, less conspicuously ideological and more experienced candidate has emerged as Britain’s next Prime Minster, ahead of difficult and multi-faceted discussions with a wounded and potentially vengeful EU.
Theresa May’s victory presents improved chances that the UK can now secure the best possible deals with its biggest trading partner.
It’s these improved chances that more domestically focused FTSE 250 shares are reflecting, given that 50% of the index’s aggregated revenues are generated in sterling, compared to around 20% of FTSE 100 revenues.
However, the fillip for UK Plc. is unlikely to bring a sustainable recovery of stock market and sterling sentiment just yet, not least because the pound is calibrated to interest rate expectations which will point lower until the second quarter of 2017 at least.
‘Short sterling’ (3-month Libor) futures have been fully pricing two 25 basis point Bank rate cuts since the referendum.
Weaker exchange rates and consumer and economic uncertainty will maintain pressure on the British-focused firms.
Additionally, whilst it is a net positive that Theresa May has proven herself to be a judicious politician who is unlikely to rush into important decisions, the probability that article 50 won’t be ‘triggered’ before the New Year is double-edged sword.
We expect the government to take a reasonable amount of time to ensure it has clearly defined strategic imperatives and recruited the best possible negotiators before giving Brussels official notification.
These efforts are unlikely to be completed sooner than the end of January 2017.
A protracted albeit necessary delay of such length will leave the most fragile British markets prone to further sell-offs.
Perhaps with an eye to that, the pound against the dollar quickly relinquished its best levels on Monday following the confirmation that Theresa May would be the next PM. We expect the rate to face a barrage of offers anywhere north of $1.30 for the next few months.
In conclusion, the end of the Conservative leadership contest and the emergence of the next British Prime Minister is a first step in fully restoring market confidence.
But British stocks and the pound still face a long road ahead even before tortuous European negotiations begin.
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Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.