In a novel change for markets, this morning’s political developments have seen sterling climb up a cliff instead of falling off one.
The pound shot higher by more than 2.5% in minutes after official exit polls showed the Conservative party with a commanding majority.
As actual constituency results confirmed that this general election was a historic victory for the Conservative party, the pound did not make any further progress, and in fact pared back its progress slightly, falling by about half a percentage point from the highs seen after last night’s exit poll.
The size of the Conservative majority has important implications for Brexit. Boris Johnson now has a wealth of options for dealing with the EU, but the trajectory of trade talks remains a major unknown factor for sterling at the moment.
With a stronger hand for dealing with Eurosceptic hardliners, Johnson is in a position to offer concessions for a free trade deal, such as the border in the Irish Sea that enabled his withdrawal agreement breakthrough.
A strong majority could prove a double-edged sword for sterling as the new Government could decide its majority means it has a strong hand for hardball tactics with the EU.
Despite questions remaining over future relations with the EU, the events represent a material reduction in overall uncertainty.
This is important for sterling, hence the 3% rally we’ve seen on the night. Despite this, sterling remains well below pre-referendum levels.
How far sterling can continue to rally over the next 12 months will depend on how much momentum the economy can regain. This will depend heavily on the behaviour of UK businesses, which have choked off investment for much of the past two years.
If UK businesses begin to invest again, combined with looser fiscal policy, the economy will enjoy a post-Brexit bump in 2020, enabling sterling to at least get a glimpse of the sunlit uplands of pre-referendum levels.