Pound surge suggests U.K. election will yield smoother Brexit

The British pound's surge since Prime Minister Theresa May's surprise election call represents an early sign of optimism that the country's exit from the European Union may be smoother than many had feared.

While the vote increases uncertainty in the short term, traders think that the expected resounding victory by May's Conservative Party could help the prime minister face down critics — both within her ranks and the opposition — in upcoming Brexit discussions.

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Spiking by more than three cents to $1.2876 US in the hours after May's announcement Tuesday of a June 8 general election, the pound hit its highest level since early October. It gave up some of those gains Wednesday, trading down at $1.2777 US.

Against the loonie, the pound went from $1.67 Cdn on Monday to $1.71 Cdn on Tuesday. The pound finished at $1.7236 Cdn on Wednesday.

So far, and it is early days, investors think May will end up with a bigger majority in Parliament, giving her a potentially stronger hand in the Brexit negotiations with the other 27 EU states.

Some opinion polls have the Conservative Party a whopping 20 percentage points ahead of the main opposition Labour Party. That sort of victory, which would be unprecedented in postwar British politics, would deliver May a majority of more than 100 in the House of Commons, compared with just 17 now.

Though May has been cautious in detailing her Brexit aspirations, traders think a big victory for her in the election could give her ammunition in dealing with those within her own Conservative Party who are urging a complete, "hard" divorce from the EU — even if that means new tariffs and an exclusion from the bloc's huge single market.

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"We see this decision as much as a decision to curtail the 'hard Brexit' faction within the Conservative Party as it is to contain anti-Brexit political parties," said Derek Halpenny, European head of global markets research at Bank of Tokyo-Mitsubishi UFJ.

It's this prospect of a so-called "hard Brexit" that has mainly worried businesses in Britain, many of which trade intensely with the EU, the biggest destination for British exports.

Brexit surprise vote sank pound

The fear of future economic damage has been reflected mainly in the pound's weakness since the initial shock of the Brexit result last June, which saw the currency tank from the $1.50 US mark to 32-year lows around $1.20 US. The currency fall has helped exporters by making their goods more competitive, but that is a one-off gain that could be more than offset by the impact of EU tariffs on British goods and additional barriers to trade.

Last month, May formally began the two-year divorce talks with the EU and laid out her hope that her government can settle the exit terms alongside talks on what the new relationship with the EU will be. The EU wants to first reach the outlines of a deal on the exit before any future relationship is discussed — a relationship it insists must be seen to be inferior to full membership.

Traders also think that a convincing election victory for May will give her greater flexibility in the talks with the EU. There won't be a scheduled British general election until June 2022, eliminating the risk of an election campaign disrupting the Brexit talks.

'Game-changer'

Deutsche Bank economists have changed their view on the pound following May's election call, which they describe as a "game-changer."

They say a larger Conservative majority, if it emerges on June 8, makes the "deadline to deliver a 'clean' Brexit without a lengthy transitional arrangement by 2019 far less pressing given that no general election will be due the year after."

They also say that a big victory for May will dilute the influence of those lawmakers pushing for a "hard Brexit" as well as strengthening May's overall negotiating stance.