What Sinn Fein’s win in Northern Ireland means for the pound, and what to look out for this week

It’s been a torrid week for risk assets generally, with US stocks suffering their longest weekly streak of losses in a decade, bond yields across the world soaring and the dollar crushing its G10 peers. This comes on the back of as troika of concerns including geopolitical issues, the Fed’s 50 basis point rate hike and a wave of inflation gripping the global economy. However, a new threat has come to the fore for the pound after Sinn Fein, the Irish Nationalist party, secured the most seats in last week’s Northern Ireland assembly elections. This result means that SF’s Michelle O’Neil set to become the First Minister of Northern Ireland if she can form an executive with her political rivals. This could de-stabilise the pound further since the goal for SF is for Northern Ireland to leave the UK and become one country with Ireland. 

Will politics destabilise the pound once again? 

Looking at the SF victory in Northern Ireland in more detail, a border poll seems unlikely in the next 1-2 years, for two reasons. Firstly, Michelle O’Neil will only become the first minister if the Protestant party the DUP, agree to join a power sharing body. Right now, they are refusing to do this. While SF can nominate a First Minister, they cannot take up the office unless the DUP nominate a deputy first minister. The DUP are unlikely to do this unless there are significant changes made to the Northern Ireland protocol in the Brexit Agreement. Thus, whether SF do reach the top office in Stormont could depend on Brexit negotiations, and the EU, as much as it relies on the DUP. 

The second reason why the SF victory does not immediately lead to the break-up of the United Kingdom is that the Good Friday Agreement states that a vote on reunification with the Republic of Ireland can only take place if there is evidence to suggest that a majority of voters would agree with it. Right now, that is not the case; the latest polls from April suggest that support in Northern Ireland for reunification is around 33%, some way off a majority. This does not mean that reunification is out of the picture, just that it is not an immediate threat. 

So, what does this all mean for the pound? 

In next day or so, the FX market is likely to digest the news that SF is the biggest party in Northern Ireland. With SF support growing, and likely to growth further due to demographic change, we could see more GBP weakness as a “UK break-up” risk premium starts to get built into the pound. While GBP/USD is falling mostly on the back of central bank divergence, a perceived greater recession risk in the UK than the US and the general strong dollar environment, another leg lower for the pound back to the $1.20 mark could be given a helping hand by the outcome of this election in Northern Ireland. The market likes certainty, and this could be the start of the break- up of the United Kingdom, which was formed in 1707 with the signing of the Act of Union between England and Scotland. 

EUR/GBP could be a more interesting trade. While EUR/USD is also getting pummelled as the dollar soars, EUR/GBP has turned a corner over the last three weeks, and has soared to its highest level since December 2021, at £0.8550. Technical indicators suggest that this pair remains a buy and there could be further sterling weakness vs. the euro in the future. A breach of £0.8500, the high from early December 2021, would be an extremely bullish signal and could trigger a rally back towards September 2021 highs at £0.8650. Overall, this pair is making a series of higher highs, which is a bullish. In political terms, EUR/GBP reflects the rising influence of SF vs. the declining influence of the DUP. If SF looks to be gaining more support nationally, especially if the DUP refuse to join the power-sharing assembly in the coming weeks, then we would expect this to be reflected in a stronger EUR vs. GBP. 

Elsewhere this week there are a few things worth noting:  

1, Last week’s rout in the global bond market, that saw global bond yields soaring and the benchmark US 10-year yield surge to 3.12%, is a keen reminder that in this current economic and monetary policy cycle, bonds are no longer the reliable haven that they once were. Overall, the US bond market’s performance in 2022 is down 20 monthly standard deviations, while the S&P 500’s is down 7. Thus, if you are looking for a lower volatility investment right now, bonds are not the place to be. After last week’s rout, we will be interested to see if the decline in bond prices/ surge in bond yields can continue. If yes, then it suggests that the market could be testing the Fed’s claim that it won’t need to hike interest rates by 75 basis points at any meeting this year, it could also mean that 10-year yields may well reach 5% by the summer. 

2, After last week’s central bank fest, this week the spotlight is on US inflation data for April, which is released on Wednesday. The market is expecting the annualised rate of inflation to pull back slightly from 8.5% to 8.1%, likewise, core inflation is expected to fall back to 6%. This data is expected to show that inflation is still growing on a monthly basis, however, at a slower pace than in recent months, for example, headline CPI is expected to have risen by 0.2% last month, compared with a 1.2% monthly rate in March. While a slowdown in inflation is welcome news, the market reaction may well be determined on what is driving price growth in the US. The key sector to watch is housing, which is the largest component of US CPI, making up 40% of the index. If shelter/ housing costs surge in April, then CPI could be pushed higher. Even if declines in food and energy prices neutralise the big rise in housing costs, it could still hurt the consumer, as rising rent and mortgage costs may constrain consumer spending in the future, and thus growth, down the line. 

3, UK GDP data is also released this week and it is expected to show a 0.1% increase for March, and the Q1 GDP rate is expected to be 1%.  This report could give the pound some brief respite, with quarterly index of services bouncing back by 2%, industrial production is also expected to have picked up in March, while manufacturing production for March is expected to come in flat after a 0.4% contraction in February. Thus, the detail of this report is key, the risk is that construction and manufacturing decline for the second consecutive month. However, the optimists among us will be looking at this week’s UK data for any signs that the bleak assessment of the UK economy by the Bank of England was too pessimistic. If there are any bright spots, we could see a mini recovery in the pound, although for the multitude of reasons above we don’t think that this will last.