Strong pound masks emerging election concerns

On the face of it, markets appear to be taking the prospect of an inconclusive outcome from May’s general election in their stride. Indeed, markets have moved to price in a slightly faster pace of monetary tightening over the next two years, helping (alongside the onset of QE in the euro-zone) sterling to rise to its highest trade-weighted level since August 2008. However, there are tentative signs that concerns about the political situation are building. The cost of insuring against a fall in the pound against the dollar around the time of the election has risen sharply. In addition, foreigners’ appetite for purchasing gilts has waned. Since the election could bring about a referendum on the UK’s membership of the EU or a less friendly tax regime for corporate profits and individual wealth, we continue to think that there is a risk that political uncertainty weighs more heavily on UK asset prices over the coming months.