Above: The Conservative Party logo. File image © Flickr, Reproduced under CC Licensing

A Tory thrashing in local elections should focus minds on the British Pound says a leading foreign exchange analyst we follow.

Next week the UK goes to the polls to elect local councillors, and a surge in discontent towards the ruling Conservative Party following the decision by government to extend Brexit until October could well see the party suffer heavy losses.

If the markets gauge the outcome of the elections to be negative, we could well see the Pound-to-Euro exchange rate descend below the 1.15 level while the Pound-to-Dollar exchange rate - which is already under pressure - would likely descend into the 1.28s.

"Local UK elections are likely to rattle the Pound," says Robert Howard, a foreign exchange analyst who sits on the currency desk at Thomson Reuters, "the Tory performance on May 2 is of prime interest."

The Sunday Times last weekend said the Conservatives might lose a net 1,000 seats and Labour gain 800, judging by recent opinion polls.

"Tory losses of that magnitude could hurt GBP by heightening fears that Labour leader Jeremy Corbyn will become Prime Minister after the next general election," says Howard.

While such an outcome would certainly be welcomed by Labour supporters, purely from a foreign exchange market perspective the current assumption is that a Labour-lead government would be potentially negative for the Pound.

The left-leaning Labour Party under Corbyn is proposing a radical shakeup of the UK economy, that includes the nationalisation of privately-held companies while the tax and spend leavers would be dramatically altered from current settings.

The Conservative Party has witnessed a substantial slide in the polls of late, with the Poll of Polls now showing the Conservatives would only command a mere 27% vote share, down from 40% in February.

Labour are on 32% and would therefore become the largest party in a parliament if an election were to be held now.

The losses suffered by the Conservatives come largely at the expense of gains in the newly-formed Brexit Party of Nigel Farage which commands 12% in the polls.

For us this suggests the Conservatives will be increasingly willing to pursue a Brexit at all costs come October 31, even without a ratification deal being secured, thus increasing the odds of a 'no deal' Brexit.

But the market still sees a negligible 15% chance such a Sterling-negative outcome transpiring.

"The one thing that does seem a relative certainty is that there will be some form of soft Brexit. The longer the Brexit process takes, and it is clearly taking a long time, the closer the final relationship between the UK and the EU will be,” says Nigel Green, CEO of deVere Group, adding:

"Against the backdrop of a likely soft Brexit, the pound currently looks undervalued."

We argue the market is currently too complacent on the risks of a 'no deal' outcome, suggesting the Conservative's will be desperate to regain the initiative on Brexit, even if it means taking the UK out of the EU without a deal come October.

A poor showing at the General Election could well renew frustration amongst Conservative Party members, increasing the pressure on Prime Minister Theresa May to announce her departure date.

This week we heard senior members of the Conservative's parliamentary party opted to not change party rules to allow for another no-confidence vote in May just months after the Prime Minister survived such a vote.

Instead, they have asked her to produce a timeline detailing her exit.

However, a drubbing at the local elections for the Conservatives might not necessarily result in a drubbing of the Pound we are told.

"Paradoxically, the worse the Tory performance on May 2, the less likely it is that PM Theresa May – or her successor – would call a general election before the end of the year," says Pace.

This would lessen the prospect of an imminent Corbyn government coming to power.

"That should soften any GBP losses spurred by a Tory drubbing," says Pace.

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