A Big Day for May, and Sterling

(Bloomberg Opinion) -- It was only two months ago that the pound was back to its pre-Brexit referendum levels versus the dollar and the Brexit process was largely on track. But times have changed, and so has the currency pair.

With a fall of eight percent since the peak in April there is a risk that sterling picks up unstoppable downward momentum. Much of sterling’s descent is due to dollar strength — but not all of it.

As the U.K.’s economic recovery has faded, so have investor expectations that the Bank of England can raise interest rates.

After Governor Mark Carney dashed hopes for an increase in the first half of the year, a mixed bag of data in the second quarter leaves the odds for a move in August finely balanced. Thursday’s policy decision is sure to be a non-event. The central bank has been forced to sit on the sidelines.

Apart from the dollar, what’s most important for the pound is politics. Wednesday’s “meaningful vote” in Parliament could give lawmakers the power to stop Prime Minister Theresa May from falling back on a no-deal Brexit. The decision could be seismic for the currency.

Allowing the legislature to have a say pretty much removes the no-deal option from the government’s bargaining table with the European Union, and severely ties its hands. Sterling normally reacts positively to hints of a softer departure from the bloc. But were this vote to pass, it would be the most important legislative failure of May’s tenure. That loss of control of the divorce proceedings would give investors serious concern about the outlook for U.K. Plc.

It could get worse. If the political fallout resulted in a leadership challenge, the disarray would be toxic for the currency, not least because there seems to be nobody who could replace her with the full backing of the Conservative Party. Sterling could easily fall below $1.30. A decline to the mid-$1.20s — the lowest range the currency’s seen since the referendum — couldn’t be ruled out, and that would be fatal for confidence in every sense.

However, if May scrapes through again, sterling ought to recover some ground. Regaining the heights of April might be too much to hope for given that we’ve yet to see a confirmed successful divorce plan, but a return to the mid $1.30s seems a reasonable expectation.

A wildcard would be if BOE policy makers clearly signaled on Thursday their determination to raise rates. But Carney’s credibility is so shot, it’s hard to see who would believe him. 

To contact the editor responsible for this story: Jennifer Ryan at jryan13@bloomberg.net

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