Sterling holds post-election gains

Sterling jumped to four-month highs against the dollar on Monday, buoyed by the election of a Conservative majority and speculation the Bank of England may provoke a change this week in bets for a first rise in interest rates. The BoE's monetary policy committee kept rates steady as expected on Monday at the record low of 0.5 percent. It issued no statement, but Governor Mark Carney is due to give a quarterly update on its growth and inflation forecasts on Wednesday.
A number of dealers and analysts said that might lead to some change in forward interest rates, which currently do not price in a rise in official borrowing costs until the middle of next year. "Primarily, this is an afterburn from the election. Some seem to have been holding back for fear of political uncertainty, and now are coming back," Citi strategist Josh O'Byrne said.
"There may be a small positive risk from the BoE's inflation report this week. Given that we have no idea what the situation is with spare capacity in the economy, two hikes by the end of 2016 just seems very conservative." The UK economy has easily outpaced most of Europe over the past two years, but shows little sign of the stronger wage and price growth that would force the bank to rein in its support for demand.
But with markets assuming the US Federal Reserve and the BoE will lead the way with rises in rates sooner or later, traders said, wages and a jobs report also due this week should keep sterling well bid, especially against the euro. The pound gained 0.6 percent against the dollar to $1.5557, and rose a full percentage point against the euro to 71.73 pence. Investors had for months worried no party would win a majority in last Thursday's election, which would have led to weeks of negotiations on a coalition government. That risk evaporated with the victory for Prime Minister David Cameron's Conservatives.
However, political and constitutional challenges remain. Cameron has pledged to hold a referendum on membership of the European Union within two years, and the Scottish National Party's landslide victory may lead to another vote on Scottish independence. "From the corporate side, everything related to referendums will be considered a tail risk," said Gian Marco Salcioli, Head of FX Sales at the investment banking arm of Italy's Intesa Sanpaolo Banca IMI. "We saw it with the Scottish vote (last year) that there was almost no reaction until the week before. This is not saying it is a massive question, but it is a sort of black-swan-event tail risk, not a major likelihood."