Like Tory Members, Markets Ponder Whether They Can Trust Johnson

(Bloomberg) -- Just as Conservative Party members are asking themselves whether they can trust what Boris Johnson says, so too are currency traders.

The candidate favored by odds-makers to succeed Theresa May as the U.K.’s prime minister may have tried to tone down his hardline Brexit rhetoric, but few investors are willing to take him at his word given his numerous about-turns.

Confirmation of Johnson as PM could see sterling slip back toward recent five-month lows, according to MUFG. And Union Bancaire Privee and Janus Henderson see a possibility of sterling sliding to $1.18, a level last seen in the aftermath of the 2016 vote to leave the European Union, by the fourth quarter should the risk of a no-deal Brexit mount.

As the odds of Johnson winning the race to 10 Downing Street increase, so do investors’ fears of the U.K. crashing out of the EU without an agreement. The former foreign secretary has edged away from his earlier pledge to leave the bloc with or without a deal and has promised that if he becomes premier, he would quickly start work renegotiating the Brexit pact. But it’s still not clear how he would win over both U.K. lawmakers and EU officials at the same time.

“The next big driver of the pound will be the next chapter of the Brexit drama and its new star Boris Johnson,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole SA. “That chapter will start only around September however.”

The pound has slumped 2.6% since the end of April to about $1.27, the worst performance among major currencies. Credit Agricole SA sees the pound at $1.24 by next quarter.

Johnson faces former remainer and Foreign Secretary Jeremy Hunt in the final round of the contest to become Britain’s next premier, with 160,000 grassroots party members voting and the winner to be announced in late July.

The U.K. Parliament goes on its summer recess on July 25 and returns on Sept. 3. This is likely to leave the pound in a holding pattern over the summer before volatility flares up again on Parliament’s return, according to BlueBay Asset Management LLP, which has a short position in sterling.

“To us it looks as if either we are heading toward a hard Brexit under Johnson, or an election with Corbyn in Downing Street at the end of the year,” said Mark Dowding, chief investment officer at the firm. “In this context we could see the pound slip to new lows.”

For the U.K. government bond market, the focus is on both the risk of a disorderly Brexit and Johnson’s promised tax cuts. The prospect of a no-deal departure is likely to prompt the Bank of England to keep interest rates on hold, while Johnson’s plan to ease income levies on high earners could cut government revenue and spur more debt sales. That could steepen the gilt yield curve, according to Mizuho International analyst Peter Chatwell.

He sees the curve between the two- and 10-year gilts steepening, with Johnson’s plans set to “put bearish pressure on long-term gilts.” The yield on two-year government bonds was around 0.61% on Friday, while a 10-year rate was at 0.84%.

To contact the reporter on this story: Charlotte Ryan in London at cryan147@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, William Shaw, Anil Varma

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