Sterling markets are right to ignore politics

Britain’s financial markets remained indifferent to the soap opera airing in recent days in British politics, with Prime Minister Boris Johnson finally announcing his resignation on Wednesday. The only Brits not mesmerized by the drama at No 10 are those who trade pounds, UK stocks and gilts for a living. For them, the economic context remains more important than who runs the government.

Greater forces at play, including runaway inflation, the cost of living crisis, the super strong dollar and the war in Ukraine, transcend internal struggles when it comes to sterling markets. A UK election is still probably two years away; the chances of big policy changes from whoever succeeds Johnson as leader of the Conservative Party to become prime minister, short of some welfare tax cuts to appease party loyalists, are slim . Any fiscal stimulus will likely be offset by further monetary tightening from the Bank of England, with consumer prices rising by double digits.

While the pound is certainly weaker against the dollar this year, that is true for all major global currencies. The euro, for example, is at its lowest for 20 years and is approaching parity with the dollar. The pound is actually closer to the highs of its post-Brexit referendum voting range against the common currency, so there is little discernible political effect on the British currency.

The construction of the UK stock market makes it somewhat difficult to read the macroeconomic outlook clearly. The FTSE 100 index has many export-focused companies enjoying stronger earnings thanks to a weaker trade-weighted pound. The index also has a larger weighting to high-dividend, value-oriented stocks rather than technology and growth components. As a result, it has outperformed most major global indices this year – but that’s not a sweet reflection on the UK economy. The FTSE 250 mid-cap index is more aligned to the domestic market and has fallen 20% this year, more in line with the S&P 500 and Euro Stoxx 600 indices.

It is the UK government bond market, known as gilts, that has the closest cross-reading to politics. Any opening of the tax spigots, if not funded largely by higher taxes as favored by former Chancellor of the Exchequer Rishi Sunak, may have to be funded by the sale of more debt. While 10-year gilt yields have more than doubled this year, from around 1% to 2.2%, this is in line with other global bond markets. Again, economics transcends politics.

There is currently a shortage of short-to-medium maturity gilts, combined with large buybacks in July and September. The gilt market can handle an increase in government issuance. The average duration of UK government debt of around 14 years is much longer than that of other major bond markets, and there is strong demand from pension funds to match their long-term liabilities.

Nevertheless, the replacement Conservative leader could well seize the opportunity of a fresh start with the European Union, which should in theory have a positive impact on the economy and therefore on the currency and certain stocks. However, until the leadership election mists clear and the more Eurosceptic candidates are out of the running, he would be a brave investor to bet big on those reset hopes with the continent. UK markets will – and should – have far more eyes on inflation and growth statistics than on the shenanigans of Westminster.

More from Bloomberg Opinion:

• Boris Johnson’s likely successors are a mixed bag: Bobby Ghosh

• Johnson is in trouble. The economy is doing well so far: Marcus Ashworth

• Brexit takes the UK back to the bad old days: Niall Ferguson

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.

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