LONDON (BLOOMBERG) - With British Prime Minister Boris Johnson's government in tatters just a week after parliament's summer break, City traders are warming to an unlikely ally: Jeremy Corbyn.
Investors have long been wary of the Labour leader given his desire to nationalize parts of the economy, boost borrowing and redistribute income. Yet analysts now see a Corbyn-led coalition as the best bet to avoid a disastrous exit from the European Union without a future relationship secured.
State Street Bank, Societe Generale SA and MUFG all see a Labour-led coalition as a more bullish prospect for the pound than the Conservative party coming to power given Corbyn's promise to avoid a hard Brexit that may upend the nearly US$3 trillion (S$4.14 trillion) economy. A grouping led by his party would spur the currency more than 5 per cent to US$1.30, they say.
"It's conceivable that Jeremy Corbyn as PM could be good for the pound, at least in the very short term," said Timothy Graf, head of EMEA macro strategy for Europe at State Street. "Most importantly, a no-deal outcome would be less likely. Indeed, given calls for a second referendum are now part of the Labour platform, Brexit might not happen at all."
The pound surged more than 1 per cent this week after Johnson suffered humiliation in parliament, with the House of Commons voting repeatedly to reduce the chances of the UK leaving the EU without a divorce agreement. The rally meant that sterling almost erased all the losses it suffered since Johnson took the helm.
TRADITIONAL APPROACH
UK investors usually prefer Conservatives to be in power, given the party's policies that promote a cautious approach to spending, lower taxes and business-friendly initiatives. And not everyone is willing to back the radical policies of opposition leader Corbyn. He has previously pledged policies such as nationalising companies and his shadow chancellor has said a future Labour government would place severe constraints on bonuses in the financial services sector.
But presented with Johnson's do-or-die Brexit strategy, some investors have started to see the big-state policies of Corbyn as the lesser of two evils.
State Street's Graf sees the pound falling to US$1.15 if the Conservatives gain a majority in an election, while a Labour-led coalition would push it up to US$1.30.
Others still see a Conservative win as the most positive outcome for the markets but worry that current polling suggests it won't happen. Instead, an election, they fear, will result in a Conservative-Brexit party alliance that pushes through a no-deal Brexit.
This would be the most "significant downside scenario for the pound," according to Erik Nelson, a strategist at Wells Fargo. The group would likely be freer to push for a no-deal Brexit if it gained a majority, and although this could push the EU to offer concessions to get a Brexit deal through, "that is hardly guaranteed," he said.
Estimates vary, but Morgan Stanley sees potential for a collapse of 19 per cent in the pound to parity if Britain quits the EU without an agreement.
For Christian Schulz at Citigroup, things have changed over the past year as the Labour party has moved much closer to supporting a second referendum while the Conservatives have become the party of no-deal. The fiscal stances of the two main parties have also moved much closer, with the Conservatives pledging extra spending and lower taxes.
"In the short term a Labour win wouldn't generate huge upside, but in the longer term, you have the potential for a second referendum and remain scenario," Schulz said. "A Labour party victory isn't a positive scenario - it's just less bad than what the Johnson government is proposing."
