Britain’s top share index came under pressure once again on Wednesday, giving up the gains it had made in 2017 as sterling held close to a six-and-a-half-month high after Prime Minister Theresa May called for a snap general election.
May’s surprise decision to hold an early election on June 8 sent sterling to its highest level since early October on hopes that a stronger majority for May, who leads the opposition Labour party by 21 points in opinion polls, will deliver a more orderly exit from the European Union. Parliament approved the election on Wednesday.
Sterling’s rise, however, weighed on the FTSE 100’s predominantly dollar-earning constituents, which have enjoyed a rally since the June referendum in which Britain voted to leave the EU.
Heavyweight oil companies Royal Dutch Shell (RDSa.L) and BP (BP.L) fell, down 2.2 percent and 1.1 percent respectively, as did precious metals miners Fresnillo (FRES.L) and Randgold Resources (RRS.L), both down nearly 3 percent.
Luxury goods company Burberry (BRBY.L) was the biggest faller, dropping almost 8 percent, registering its worst daily performance since October 2015 after reporting a slight slowdown in its fourth-quarter comparable sales growth rate.
A slight slowdown in fourth-quarter like-for-like retail from the third quarter may give the market pause for thought, analysts at Liberum said in a note.
“News of a snap UK election has seen a strong rally in GBP. Should this continue towards polling day, Burberry’s own FX-driven rally could disintegrate. We urge investors to take profits and sell from a position of relative strength,” they added.
Companies with a more domestic focus, however, such as grocer Sainsbury (SBRY.L), budget airline easyJet (EZJ.L) and Royal Bank of Scotland (RBS.L), were among the biggest gainers, all up by about 5 percent.
“The interesting second-order effect from the sterling move is the inflation story because that’s been a big concern, particularly on the consumer-facing stocks … (because) of what it does to their input costs,” said Peel Hunt strategist Ian Williams.
“Historically, the sectors that do relatively well when sterling is rising tend to be … the more domestic-focused ones; so real estate, retail.”
Britain’s FTSE 250, constituents of which have greater exposure to the UK economy, recovered some of the previous session’s losses and held close to record highs.
“The mid and small-caps were among the hardest hit after Brexit. If we saw the pound strengthening and the UK consumer continuing to be resilient, that would really benefit small and mid-caps,” said Henderson UK equity income and growth manager Laura Foll, adding that Henderson is overweight on mid-caps.
I believe that decline of Shell’s and BP’s shares is more related to the sustained low oil price environment coupled with wide range of uncertainties due to international politics issues.
Drop of luxury goods stocks is also logical as with Brexit, international banks would relocate causing sizable cut of consumer base. The same could be relevant to the real estate industry and other services.
What confuses me, however, that sterling is strong due to hopes that May will deliver a more orderly exit from the European Union.
I am not an expert in forex but I wonder what does it mean “more orderly exit”? Is it procedural or some other issue? Because if investors think that Theresa May well positioned to deliver favorable outcome of negotiations with the E.U., I afraid that they might be hugely disappointed.
There will be two parties in this negotiation process – the U.K. and the E.U. The European Union has much stronger position for many reasons. One of the reasons is political and the E.U. would most likely use its strength to ensure that potential for domino effect is eliminated.
It is possible that international banks would relocate to the E.U. to secure access to bigger market. If we consider that banking industry plays the essential role for the U.K., their departure, or at least relocation of their HQs, would be painful.
If we take into consideration the above numbers, strong position of sterling based on investors hopes, appears rather surreal.