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Risks looming for sterling bulls

Focus is on election, but UK growth cratering, foreigners big-time underweight London stocks and a complex EU trade deal to be worked out even if Conservatives win.

GBP/USD forex trading Source: Bloomberg

With sterling up strong in recent weeks, holding on to big gains even as Brexit uncertainty remains as high as ever, GBP/USD traders have been focused on the election to the exclusion of all else.

Sterling is now getting a lift every time Boris Johnson’s Conservatives appear closer to winning the election, a complete reversal from just a short while ago when a rise in Boris Johnson’s fortunes used to send GBP/USD tumbling.

Last week we were witness to the unique phenomenon of a surge in sterling on news of an alliance of sorts between the Brexit Party and the Conservatives. That GPD/USD was up 1% on the week was due largely to Brexit Party leader Neil Farage’s announcement that he would not run candidates in Conservative held ridings, thus substantially increasing the chances of Johnson hanging on to his parliamentary majority.

Much less eager

A fundamental truth about Brexit so far is that members of parliament appear to be much less eager to see Brexit realized than perhaps their constituents, a disconnect that may or may not work itself out in the upcoming election, and one that is at the root of why Brexit votes in parliament were such cliffhangers recently.

And even if the UK’s muddy political waters suddenly clear up post election, say with Johnson given a clear mandate, there remain enormously complex and fraught negotiations with the EU to be executed.

Negative fundamentals piling up for sterling

Amidst election mania, traders shrugged off news last week that the UK economy is in the tank. GDP growth was 0.1% in the third quarter, so a recession – defined as two consecutive quarters of negative growth – was avoided. But what was less noticed was that second quarter growth was revised downward. All told, the UK economy is in its worst shape in a decade.

Even if Brexit is executed relatively smoothly, economists expect a rupture with the EU to knock a half percentage point off UK growth every year for years.

Brexit uncertainty, which even in the best of circumstances is likely to continue well into the future, is having a highly deleterious effect on foreign capital flows into the UK. Just one example: international investors are hugely underweight London stocks.

GPB/USD price action

Sterling has traded in a rough band between $1.30 and $1.28 over the last month or so. Since there won’t be any real news about the election until the election itself, and GPB/USD is up a very strong 5% in recent weeks, Sterling bulls may take the opportunity in the interim to take some profits.

Near term, GBP/USD bulls have to contend with the formation of a double top in the daily chart, typically a negative from a technical analysis standpoint.

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