Pound Views Diverge as Leadership Contest Moves Up List of Risks

(Bloomberg) -- As the pound is thrashed around by Brexit politics, currency strategists see the risk of a deeper slide on a leadership challenge for U.K. Prime Minister Theresa May.

Sterling recovered some of this week’s losses on Friday as pro-Brexit minister Michael Gove confirmed he wasn’t resigning from May’s Cabinet, though there’s speculation that enough lawmakers have lost confidence in her to force a vote next week. If May can cling on, opinions diverge on whether Parliament will back her draft Brexit deal, seen as the main risk for the currency this year.

Here’s what some strategists are saying amid the uncertainties shrouding Westminster:

Credit Agricole

  • “The Brexit deal proposal has so far triggered a torrent of criticism and rejections that suggested there is a significant number of MPs who would vote against it,” wrote strategists including Valentin Marinov
    • A fluid political situation, coupled with the fact that investors are already short GBP, may explain why the pound is not even weaker given the latest developments
  • Shorting the pound could become the path of least resistance; failure to reach a Brexit deal before year-end could push GBP/USD toward 1.20, and could see EUR/GBP testing 0.9200 before long

Danske Bank

  • Risks are skewed on the upside for EUR/GBP as speculation of a leadership challenge is likely to develop further, says Christin Tuxen, head of currency strategy
  • Still, lowers one-month EUR/GBP forecast from 0.88 to 0.84 as it remains bank’s main scenario that the House of Commons eventually will vote in favor of May’s Brexit deal
  • Says probability of other scenarios, such as no deal, has increased

Mizuho

  • Market has priced in leadership challenge, but has not factored in May’s resignation, and a possible second referendum “is certainly not in the price”, says Neil Jones, head of hedge fund sales
  • Sees pound slipping to 1.2250 if May does end up losing confidence vote

Morgan Stanley
  • Increased uncertainty suggests pound stays under selling pressure for now, with August low near 1.2665 the level to watch, as a break below that could suggest a move down to 1.2450, wrote strategists Hans Redeker and David Adams
  • Retains long-term bullish view; eventual resolution of a divorce deal could support long-term capital flows back to the U.K.
    • Continued improvement in macro data suggest BOE will be able to pursue a more aggressive pace of tightening following removal of Brexit uncertainty; steeper yield curve should further bolster pound’s attractiveness

RBC

  • The best scenario for sterling is a second referendum with remaining in the EU an option, which could lead to a surge to $1.41, according to strategist Adam Cole
  • The worst is crashing out of the bloc without a deal in March, either via a new prime minister who is a Brexiteer or from May’s deal failing to pass a Parliament vote, driving a slump to $1.15

©2018 Bloomberg L.P.