Reflecting on April: A rally from sterling

Sterling strength and the Bank of England's latest decision

We reflect on how the announcement of the next general election impacted the pound and the Bank of England’s decision to end its Corporate Bonds Purchase Scheme, considering what these could mean for investors.

Sterling Rallies

What has happened?

Sterling rallied in April, gaining 3.2% against the dollar and 0.9% against the euro. Most of the gain occurred on the day Theresa May announced that she was seeking to hold a UK general election in June.

Why?

The prospect of having to hold the next general election just a year after the end of the two-year Brexit negotiations period put pressure on the Prime Minister to deliver Brexit on time, whilst having to rely on a small majority in Parliament. This arguably increased the possibility that negotiations could end with a deal which could adversely impact the UK’s economy. By calling for a snap election in June, Theresa May is expecting to increase the Conservative majority in Parliament, which she has argued would provide her with a stronger mandate to negotiate the UK’s exit from the EU. The move also pushes the date for the subsequent general election further into the future, potentially providing the Prime Minister with more flexibility over agreeing a transitional arrangement. These factors were seen by the markets as increasing the prospects for a more orderly exit from the European Union, an outcome which should be positive for the currency.

What should you take away from it?

Sterling’s reaction to the election announcement indicates how political developments can impact financial markets. The FTSE 100 Index, whose constituents derive the majority of their earnings from abroad, was negatively impacted by the rally in sterling in April. Although political developments and headlines related to the Brexit negotiations will continue to influence sterling in the foreseeable future, fundamentals will also matter. For example, markets are currently not expecting an increase in UK rates until at least late 2018, whilst in the US the Federal Reserve is expected to continue to raise rates gradually. As the rate differential between the pound and the dollar increases, the former becomes relatively less attractive.

Bank of England Ceases Corporate Bonds Purchase Scheme

What has happened?

On 27 April, the Bank of England (BoE) announced the completion of its Corporate Bond Purchase Scheme (CBPS). Through this operation, the Bank purchased sterling-denominated, non-financial corporate bonds issued by UK companies or overseas businesses with significant operations in the country.

Why?

The programme, which was launched on 27 September, was aimed at stimulating the British economy in the aftermath of the Brexit vote. Through direct corporate bond purchases, the BoE intended to lower the yields on corporate bonds, with the aim of reducing borrowing costs for companies, increasing issuance of corporate debt and incentivising investors to rotate into riskier assets. The programme ended after reaching its target of £10bn after just seven out of the initially planned 18-months operating period.

What should you take away from it?

Measuring the success of a particular monetary policy is not always straightforward, as it’s not known certain what the outcome would have been had the policy not been implemented. However, in terms of average corporate bond spreads (the difference between a yield on a corporate bond and a similar maturity government gilt, which is a way of assessing corporate financing costs), most of the market impact came from the announcement of the programme rather than its execution. The Barclays Industrial Corporate Bond Index, which includes sterling-denominated, non-financial, investment-grade corporate bonds of the kind the Bank of England was purchasing, fell to a two-year low of 112bps in the days after the announcement. The spreads, however, have subsequently risen and at the close of the programme, the average spread stood at 127bps.