Why pound’s relief on Boris Johnson victory may not last 

A SIGH of relief for UK investors after Boris Johnson’s leadership victory is proving temporary, as focus sharpens on the nation’s worsening economy. 

The pound slid against the dollar into the European session, erasing a knee-jerk bounce on Monday (Jun 6) spurred by Prime Minister Boris Johnson winning a confidence vote in his leadership. A looming growth slowdown is keeping longer-term measures of sterling sentiment near the most bearish levels since 2020, while political turmoil is set to continue even after the vote.

The battle for the Conservative Party leadership comes amid a cost-of-living crisis that’s threatening to plunge the economy into a recession. That’s piling pressure on the Bank of England (BOE) to support growth and rein in the highest inflation in four decades, while keeping pace with the Federal Reserve and other global peers - a process pound traders will be watching very closely.

“For the time being the focus for sterling will be the BOE versus Fed pricing, global risk sentiment and the twist and turns of this fast-moving business cycle juggling recession versus slowdown risks,” said Jordan Rochester, a currency strategist at Nomura International Plc. 

Sterling fell as much as 0.8 per cent to US$1.2431, following the vote which showed 211 Tory MPs favoured Johnson’s leadership compared with 148 against.

The UK currency is the third-worst performer among Group-of-10 peers this year, trailing only the Japanese yen. One-year risk reversals on the pound versus the dollar - a gauge of sentiment - are near the most negative since September 2020 on a closing basis.

Less secure

Johnson’s victory means he’s immune from another challenge for a year under current party rules, but he’s not necessarily out of the woods. His predecessor Theresa May survived a similar vote in 2018 - and by a wider margin - only to resign months later.

The vote is a signal that his leadership is less secure, “which raises perceived risk of cabinet resignations in coming weeks,” said Alan Ruskin, chief international strategist at Deutsche Bank. That said, Johnson’s win won’t likely impact investors’ strategy on the pound in the longer term.

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The UK prime minister has faced widespread calls to resign since it was revealed he attended parties at his official London residence on 10 Downing Street in a breach of lockdown rules his own government wrote.

Confidence votes against former premiers - from May to Margaret Thatcher - have moved the pound in the past. But this time, investors are focused on other macroeconomic factors, namely the gap between US and UK interest rates and a looming economic slowdown.

‘Stay aggressive’

With the BOE convening on Jun 16 - a day after the Fed is expected to deliver a half-point rate hike - traders will be watching for just how much the central bank will tighten.

It has unleashed 90 basis points of rate increases since mid-December, which has led to the slowest quarterly growth rate since a contraction in the first 3 months of 2021. 

BOE Governor Andrew Bailey acknowledged the cost-of-living crisis in comments last month, saying it’s holding back the UK economy and that policy makers will take that into account in gauging how much to raise interest rates.

“The BOE will have to stay aggressive in hiking,” said Clifton Hill, global macro portfolio manager at Acadian Asset Management. “Growth will be a problem later this year as rate hikes start to really affect the economy, but solid enough for now.” BLOOMBERG