PM Theresa May’s snap election backfires in the U.K., weakening the pound; dollar strengthens; oil drops

A snap election in the U.K resulted in a hung parliament, weakening the governing Conservative’s position ahead of Brexit. Conservatives won 318 seats with a majority requiring 326 seats. The Labour Party won 261 seats, followed by the pro-independence Scottish National Party with 34.

Northern Ireland’s Democratic Unionist Party (DUP) has indicated it will help form a minority government with the Conservatives, giving Prime Minister Theresa May a razor-thin majority, but markets are concerned it may not be enough to confidently navigate the impending Brexit negotiations.

May called the snap election seven weeks ago while holding a 17-seat working majority and most polls predicting the Conservatives would come out of the polls winning seats and firming up control for Brexit negotiations. The unexpected losses represent a major political defeat for May and the Conservatives, and sources close to the prime minister said that she will stay on for the time being, but it is hard to see how she can carry on in the role beyond the short term, reports Stratfor.

E.U. leaders expressed fears that May’s shock loss of her majority would delay the Brexit talks and so raise the risk of negotiations failing. The subsequent uncertainty saw the pound sterling fall to multi-month lows. The pound weakened to as much as $1.2632 before recovering to $1.2742, still down about 2% against the dollar.

Until a minority government is officially formed, there is still more downside risk for the pound, too. The median expectation for the pound is currently $1.2350, according to Tapas Strickland, an economist at the National Australia Bank.

“At the end of the day, I think we’re probably going to get some sort of a coalition or a majority, it’s just going to be too slim,” said John Gorman, managing director of rates trading at Nomura Securities. And then it questions: Is there going to be gridlock in the U.K. government? Is there going to be a change of leadership in the U.K. government? And that’s not an ideal situation. But once the dust settles, there is going to be this idea that the markets are going to be pricing in a softer Brexit and that’s going to be better for the sterling.”

Fall in the pound could be a correction

Another explanation for the drop in the pound today was the expectation that the Conservatives would win a sweeping victory was already priced into the currency.

Elsa Lignos, managing director of foreign-exchange strategy at RBC Capital Markets, noted that the pound had priced in a premium since the snap election was called in mid-April, as markets assumed a Tory victory.

“Effectively, markets moved very quickly to price in a Tory majority. Now, we’ve unwound about half of that,” she said, citing the $1.2550 level it traded just before the election was announced as a target.

But she noted that with a hung parliament, the pound would have further to fall.

“It’s very unclear where we go from there,” she said, citing uncertainty over parties’ ability to form a coalition. “Given that uncertainty, it’s very difficult to aggressively jump in and buy sterling here.”

The dollar strengths against other currencies

The dollar strengthened 0.47% to 97.37 against a basket of other currencies following the testimony of former FBI Director James Comey before the U.S. Senate. The stronger dollar will make it more expensive for holders of other currencies to purchase dollar-denominated commodities such as oil. This, in turn, will create downward pressure on oil prices if the dollar continues to strengthen against other currencies.

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