With five trading days until Britain exits the European Union, investors are showing faith in U.K. assets.
The month since the Conservatives’ election victory has seen $1.9 billion pour into U.K. equity mutual funds, according to EPFR Global data, while government bonds are the best performers in the region.
Market sentiment has improved amid expectations Prime Minister Boris Johnson’s new parliamentary majority will unleash a wave of government and private spending to revive growth. December’s general election helped ease the U.K.’s political paralysis and swept away fears of a messy divorce from the European Union on Jan. 31.
“Business confidence has improved sharply since the election and risen to multi-year highs,” Lee Hardman, a currency strategist at MUFG Bank Ltd. “It should reinforce optimism over a cyclical rebound for the economy which should be positive for U.K. assets and the pound.”
Purchasing Managers’ indexes for British manufacturing and services pointed to a nascent recovery on Friday, with the numbers above economists’ estimates.
In the week which included Johnson’s election victory, over $1 billion was invested into U.K. equity mutual funds, with the net flow rising to about $1.9 billion through the week ending Jan. 15. Sterling issuance in Europe’s publicly syndicated debt market has set a record in January at 24.4 billion pounds ($32 billion), according to data compiled by Bloomberg.
The British currency saw its best week since December, though it pared gains Friday after the latest indicator of British economic output wasn’t strong enough to rule out a reduction in the Bank of England’s benchmark rate next week. That prospect has been driving gains in gilts along with haven demand, taking benchmark yields to the lowest since October.
The pound’s final days with Britain still in the EU may turn into a tug-of-war between the upside from renewed economic optimism and the downside from the potential interest-rate cut. Yet, the currency betrayed little nervousness ahead of the Jan. 30 decision, staying above the psychological $1.30 mark and several technical support levels.
“ There is a clear bid tone to the pound,” said Jane Foley, the London-based head of currency strategy at Rabobank. “This can be linked with the anticipation that more stable political conditions post the election should release pent up investment demand. A rate cut may not be able to unseat this perception for very long.”
That’s a turnaround for a currency that has declined 12% in the 43 months since Britons voted to exit the EU. Longer term, U.K. assets could face pressure if trade talks turn sour with Brussels.
Pound to Struggle as PMIs Seen Failing to Ward Off Rate-Cut Risk
However, the weakness may not last and may even represent a last bout of selling before the currency finds a bottom. Options traders are growing less bearish on the pound.
“Why the pound has struggled to really sell off hard, even when BOE-cut expectations hit 70%, is a function of overseas investors having been underweight in U.K. assets since the referendum,” said Neil Jones, the head of currency sales for financial institutions at Mizuho Bank Ltd. in London. “Now, they’re beginning to address that balance by buying into sterling-denominated bonds, stocks, real estate and companies.”
While pound traders have been cautious in pricing in a rate cut next week, the rates market has been bolder. The 10-year yield is sending signals for a reduction, continuing a trend since October when it has shown a divergence from currency moves. The pound and government bonds are disagreeing so much that their 60-day rolling correlation has fallen near the lowest level since May 2017.
“The rates market has put more emphasis on dovish comments by policy makers whereas the currency has taken a more balanced approach,” said John Wraith, the head of U.K. rates strategy at UBS Group AG.
“Our main question is whether the currency market is right or the rates market is right.”