Currency investors commenced their own efforts to protect themselves against the risk to sterling posed by the most undecided British election for decades, having learned a rather difficult lesson in the run up to Scotland’s independence referendum.
Sterling fell sharply and the surge of volatility in the preceding days of September’s vote belated investors to the probability that Scotland could break away from the rest of Britain which would adversely affect the investment and economy of Britain.
This time particularly, insurance against violent price swings will be strategically placed before the May 7 parliamentary vote.
Six-month sterling/dollar implied instability, the premium to hedge with alternatives that will cover the election period has surged which outstripped an increase in euro/dollar implied volatility by hitting 9.6 % last week which was its highest since June 2012 and signaled the rise from around 7.7 % over a month ago.
Volatility surrounding the election has been bid up which many experts say might not even be enough since political risk is already weighing much on sterling.
It was able to hit an 18-month low of $1.5034 last week as investors started to price in risks of another possible fractious coalition government and a future referendum on Britain’s membership of the said European Union.
A key election issue is the conventional Conservative and labour parties that opposite views to Britain’s big budget deficit. The Conservatives posits deep spending cuts to generate a surplus by the year 2018-2019 while labour plans to mix of cuts and tax rises in order to balance the budget during the next five years of parliament.
Polls indicate a third of the electorate plans to vote for other parties, yet most noticeably the anti-EU UKIP. Goldman Sachs consider the outcome of the election is the least certain in the century.
Two opinion polls that were done last week underlined the probability in which one gave the conservatives a six-month point lead with an estimated 34 % of the vote while the other placed labour five points ahead on 37 % respectively.
This raises the possibility of days or even weeks of wrangling as two or more parties attempt to replicate a coalition, a period investors strongly believe will be volatile and damaging for sterling in general.
When there’s a dense haze and investors couldn’t possibly see through it, there exists a risk premium and the same is suppressed by the value of a currency.
Once burned shy away again?
It is not the instantaneous aftermath of the vote that is vague and that makes calculating an appropriate risk premium for sterling very intricately difficult. The largest political risk for the pound was a referendum in EU membership as promised by the Conservatives by 2017 should they reestablish their power.
Nine-month and a year the sterling/dollar implied volatility which was able to capture price action up to October and January correspondingly has likewise spiked to almost two-year highs as investors agonise that a vote to leave the EU would adversely affect the economy and drag down the sterling.
It’s not quite certain that the election will bring clarity in the EU referendum and that’s still requires persistent follow-up.
Another impending risk is that the Scottish National Party whose support in Scotland soared at the expense of labour which might seek for a second referendum on independence as the cost for forging any coalition.
Finally, the Scottish referendum itself modified the dynamic and the likelihood that one faces in the looming May election.