GBP: Weaker reaction to UK political risks for now – Nomura

Research Team at Nomura, suggests that unsurprisingly, UK political risk has had less of an influence on GBP recently.

Key Quotes

“Ahead of the UK referendum, proxies for Brexit risks, such as the probability of Brexit based on the betting market, had a strong impact on GBP crosses. If we look at the correlation between GBP and the UK sovereign CDS spread, the correlation was negative ahead of the UK referendum. A 1bp rise in the UK sovereign CDS spread weakened GBP/USD by 0.3-0.4% in Q2.

However, GBP’s sensitivity to changes in the UK’s CDS spread has weakened to almost neutral at the moment. The spread peaked on 27 June and has started to shrink gradually since then, but GBP has been trading weakly. The sovereign CDS spread may not be the best indicator of UK political risks, but GBP has been less adversely affected by UK financial sector CDS and financial equity prices as well.

GBP still reacted negatively to the headline about the timing of triggering Article 50 (“UK said to see Brexit most likely triggered by April 2017”) on 19 August, which suggested the FX market still reacts to political headlines. Nonetheless, bookmaker odds show that Q1 2017 is now the most likely timing of Article 50 being triggered, and there is likely to be limited new information to drive GBP in the near future. There will still be political headlines related to the Labour Party leadership contest, the possibility of a general election, the budget, further clarity on the timing of Article 50 being triggered and so on, but for now, GBP’s weaker sensitivity to UK political risks makes sense.”