The snap UK election on 8 June is not expected to create any additional uncertainty for the GBP, but it has implications for the Brexit outcome and the overall risk assessment of the sterling.
In our main scenario, we expect the Conservatives and Theresa May to consolidate the majority. In this scenario, the UK is still set to leave the single market and the custom union but the risk of a 'no deal Brexit' is lower.
We expect valuation and positioning to offset GBP weakness driven by possible election risk premiums ahead of 8 June. We target EUR/GBP at 0.84 in 1M but stress that a more hawkish rhetoric from the ECB in June is an upside risk factor.
We expect EUR/GBP to settle in the 0.82-0.8650 range post the election targeting the cross at 0.84 in 3M and 0.83 in 6-12M, as lower Brexit tail risks justify a less undervalued GBP in the medium term. Importantly, we still expect EUR/GBP to remain volatile and sensitive to developments in Brexit negotiations.
We expect the FX option market to price in a higher election risk premium as the Election Day approaches and while we remain strategically bearish on the GBP, we recommend real money funds and pension funds to consider buying 1M or 2M EUR/GBP put option if the spot bounces up to 0.8550.
We recommend EUR- and DKK-based corporates to hedge GBP income via risk reversals.
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