British Pound Volatility to Spike on BOE Decision, Blair Resignation

British Pound faces two major event risks tomorrow. The Bank of England (BoE) rate decision and the expected announcement of a resignation by Prime Minister Tony Blair - How could the GBP respond?

After 10 years of service, British Prime Minister Tony Blair?s once shiny reputation has been tarnished by his support for the Iraq war. As a result, Mr. Blair is expected to announce his plan to resign on Thursday, well before the next official election in 2009, and the position is widely expected to be handed down to the Chancellor of the Exchequer Gordon Brown. Although Brown may be a shoe in for the job, the last time that we saw a change in leadership, there was very volatile price action in the British pound. With the Bank of England anticipated to hike rates Thursday morning as well, what will we see this time around?

Handing Off the Labour Torch to Gordon Brown
On May 1, 2007, British Prime Minister Blair marked the tenth anniversary of his leadership, and also indicated that he would establish his date of departure from office the following week. Chancellor of the Exchequer Gordon Brown, who has been endorsed by Mr. Blair, is the clear favorite. Moreover, it appears that the way is being cleared throughout the UK government, as current home secretary John Reid has resigned in order to give “the maximum opportunity to Gordon to bring in fresh talent, newer people.” Meanwhile, MP Michael Meacher agreed with his potential left-wing rival John McDonnell that whichever of them received the least nominations would withdraw to give the other a better chance, highlighting the challenge Mr. Brown presents as the front-runner candidate.
On May 10th, Tony Blair?s announcement could cause the British pound to show a similar reaction to 1997, when the Prime Minister was initially elected. In the early days of May 1997, GBP/USD showed a rocky 200 point range amidst conflicting sentiment, as the Labour Party?s reputation for massive amounts of public spending ran counter to Gordon Brown?s surprise decision to make the Bank of England independent while also hiking rates 25 basis points. Interest rates eventually won out, as the British Pound rallied nearly 800 points over the follow two months.

Same Party. Same Policies?
Mr. Brown, the longest serving chancellor of modern times, has often been applauded for helping guide the British economy through booms and busts. However, the role of Prime Minister would give Mr. Brown far greater control, so it is worth noting what kind of policies he would likely enact. Mr. Brown tends to favor “big government” policies like Mr. Blair, and has gained some opposition in his quest to raise taxes in order to pay for increased spending. As a member of a transport and general workers union called Unite, Mr. Brown has been heavily criticized by civil service union leaders for announcing thousands of job cuts in government departments and agencies, a decision which has sparked a series of strikes. Looking forward, it is expected that Mr. Brown may consider cutting corporate taxes in order to keep big businesses in the UK. While businesses will surely see the potential of lower taxes as a major benefit of Brown-leadership, his reputation for liberal public spending are not typically taken as bullish measures for national currencies.
Will the British Pound Repeat 1997?
In order to gauge the reaction of the British Pound?s this time around, we must also consider current economic scenario. The UK expansion continues to move along quite nicely and a booming housing market has helped fuel inflation - creating ample conditions for policy tightening by the Bank of England. In fact, the central bank is predicted to raise rates 25 basis points on Thursday as well. However, given the lofty levels of GBP/USD (the pair is still near 25 year highs), there could be limited upside potential for the pair. Should traders perceive the continuation of Labour Party leadership as a negative for the UK, any bearish moves from resistance at 2.01 may only be exacerbated.

There are two major caveats to consider this Thursday: If the Bank of England decides to 1) signal another rate hike in June or 2) raise rates by a full 50 basis points rather than 25 basis points, the British pound may ignore the political news to challenge the record highs once again. However, the sentiment may wane over the next few weeks as political turmoil in the UK and pessimism towards a Brown premiership could weigh on the British pound.