Overview
Deutsche Bank says the British pound has shown little change in its risk premium over the last two weeks, even as market participants increasingly expect Andy Burnham to become Prime Minister in mid- to late July following his victory in the Makerfield by-election. According to the bank, investors have effectively been trading for several weeks on the assumption that Burnham will take office in time for the Autumn Budget, and an updated Deutsche Bank chart on sterling's risk premium records minimal movement during that period.
Shift to Chancellor Race
With the question of who will occupy Number 10 appearing to be largely priced in, market focus has moved toward the appointment of the next Chancellor. Deutsche Bank notes that former Health Secretary Wes Streeting's decision not to enter the leadership contest coincided with an increase in his implied probability of replacing Rachel Reeves. The bank characterizes Streeting as among the more market-friendly prospective candidates.
The bank also points out that prediction markets currently place roughly a 20% probability on former Labour Leader Ed Miliband, whom those markets see as the most left-wing of the potential candidates under consideration. Deutsche Bank does not alter its view that headline risks tied to fiscal policy are likely to resurface later in the summer.
Fiscal Headlines and Underlying Fundamentals
Deutsche Bank warns that stories about the scale of the UK fiscal shortfall, potential changes to fiscal rules, and the prospect of tax increases are likely to return to the forefront of market attention later this summer, irrespective of who occupies Number 10 or Number 11. The bank emphasizes that the underlying economic fundamentals and macro-level questions that inform the UK outlook remain unchanged.
Gilt Market and Currency Positioning
From a rates perspective, Deutsche Bank's team highlights that gilts have not experienced the same degree of curve flattening as some peer sovereign bond markets over the past week, and that a risk premium in bond markets remains present. In currency positioning, the bank continues to hold a long GBP/NZD exposure, arguing that the risk-reward profile favors a gradual strengthening of the pound against selected risk-sensitive currencies.
Implications
The bank's read is that sterling has largely digested the political development around the expected Burnham premiership. With attention moving to the Chancellor nomination and the lingering fiscal debate, market and policy uncertainty is expected to re-emerge as fiscal details are addressed.