Pound’s Post-Election Rally Is Seen Challenged Into Second Week

The pound’s world-beating performance this week following the U.K. election is prompting strategists to question whether the currency has room to appreciate.

After Britain’s May 7 election unexpectedly produced a comfortable win for the Conservative Party, sterling rallied 3.7 percent by May 13 to its highest level this year versus the dollar. Then it pared gains as investors’ attention shifted back to the mixed prospects of the U.K. economy.

In their sights are the Bank of England’s minutes from its latest policy meeting, at which officials kept interest rates at a record-low 0.5 percent. They’ll be published on May 20. With inflation at zero, increases in borrowing costs that may support the pound aren’t being priced in for a year.

Nonetheless, there are still signs of economic growth. Retail sales rebounded in April, climbing 0.4 percent, following a 0.5 drop in March, according to the median estimate of economists in a Bloomberg survey.

“We’ve had quite a reaction off the back of the election and, at least in terms of cable, we’ve had an overextension,” said John Hardy, head of foreign-exchange strategy at Saxo Bank A/S in Hellerup, Denmark, referring to the pound versus the dollar. The currency pair “is settling into a more neutral zone. If you’re looking for sterling upside it could be interesting on euro-sterling.”

Best Performer

The pound gained 2 percent in the week to $1.5771 at 5 p.m. London time Friday. It reached $1.5815 the previous day, the highest level since Nov 27. Sterling was little changed at 72.48 pence per euro compared with May 8, after the previous week’s gain. The pound was the best performer since May 7 of the world’s 17 major currencies.

The U.K. currency still has room to fall back to $1.55 as markets feel out a new range, Hardy said.

Britain’s inflation rate will remain at zero in April, economists forecast in a Bloomberg survey before the data are released on May 19. The BOE said this week that consumer-price growth would return to its 2 percent target in two years based on market expectations for the central bank to gradually raise interest rates from mid-2016.

There is a strong case for foreign-exchange reserve managers to diversify into the pound now that the political uncertainty has passed as it’s still a relatively high-yielding currency, according to Citigroup Inc. HSBC Holdings Plc takes a different view, saying the governing Conservative Party’s pledge to hold a referendum on Britain’s membership in the European Union creates medium-term risk and so the pound will not sustain gains above $1.55.

U.K. government bonds declined for a fifth consecutive week amid a global selloff in debt, spurred by investors revolting against record-low and negative interest rates in Europe.

The 10-year yield was little changed in the week at 1.88 percent. The price of the 5 percent bond due in March 2025 was 127.815 percent of face value.