The pound is in for a bumpy ride

On a trade-weighted basis, the pound has hit its highest level since the summer of 2008. But the next few months could be very different.

While all the talk in the forex markets has been about the strong dollar, sterling hasn't been doing too badly either. True, it has drifted down to an 18-month low against the dollar, as investors expect interest rates to rise there before they do in the UK. (Higher rates make assets, and the currencies they are denominated in, more appealing.)

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However, on a trade-weighted basis, it has hit its highest level since the summer of 2008. Against the euro, it has reached an eight-year high.

But the next few months could be a different story. In the currency options market, the "implied volatility" for the pound/dollar exchange rate over the next two months has doubled since March; in essence this means that investors are willing to pay more to hedge against sterling volatility.

One reason may be the fact that the general election is fast approaching. Politics can easily lead to plenty of turbulence the pound suffered a nasty jolt last year when a poll showed a lead for the "Yes" vote in the run-up to the Scottish referendum.

This time round, the uncertainty may last longer. Protracted horse-trading is a possibility as parties try to cobble together a coalition. Most of the likely election outcomes "point to a weaker sterling", says HSBC. Commerzbank's Peter Kinsella cites the prospect of a referendum on EU membership as a key worry.

One outcome of any vote to leave the EU would be a potential fall in foreign direct investment from Europe. That would make it much harder to fund the UK's current-account deficit.




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