The Pound Would Only Have a Short Rally If Boris Johnson Isn't the Next U.K. PM

(Bloomberg) -- A surprise win for underdog Jeremy Hunt in the contest to become U.K. prime minister would cause the pound to rally from near a two-year low -- but not for long.

A victory by Hunt, who was only backed by 26% of Conservative Party members in a recent poll, could cause a jump in sterling as he is more likely to avoid the U.K. crashing out of the European Union without a deal, strategists say. The relief would only be temporary given he is likely to face the same problems as incumbent Theresa May: the challenge to renegotiate a deal that Brussels has refused to reopen and to win support for it in a divided Parliament.

“It wouldn’t have a sustained impact in part because the risk of an accidental no-deal Brexit may persist even with Hunt at the helm of the Tory party,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole SA.

Former Mayor of London Boris Johnson, the overwhelming favorite to win, has pledged to lead the U.K. out of the bloc by the Oct. 31 deadline,“do or die,” with or without a deal. The result of the vote on the duo by Conservative members is expected on July 23, in a contest sparked by May stepping down after failing to get her Brexit deal through Parliament.

Both May and Hunt backed remaining in the bloc in the 2016 referendum, though both have since embraced Brexit. Hunt has said he would pursue a no-deal exit with a “heavy heart” if the EU refuses to renegotiate. He has said he would delay Brexit again if there’s a good chance of improving the deal.

Hunt is “May 2.0,” said Societe Generale SA strategist Kenneth Broux. He sees the pound rallying as high as $1.27 on a win for the Foreign Secretary before the currency gives back those gains when Parliament returns in September. The pound has slid 4% in the last three months as the risk of no deal grows. It gained 0.3% to $1.2534 on Thursday as the dollar weakened.

“Hunt does not change my view that pound rallies are still a sell until there is clarity around the Oct. 31 deadline,” Broux said.

It’s not just the politics worrying pound traders. The U.K. economy is headed for a contraction in the second quarter, according to a Bloomberg survey of economists, and a gauge of data performance versus expectations is at its lowest level since 2011.

Demand to get exposure to pound gains through options remains subdued. Investors in the U.K. currency prefer to bet on a fall, with interest intensifying around the Brexit deadline on Oct. 31.

The U.K. is likely to continue to underperform “growth wise and politics wise,” according to Jordan Rochester, a currency strategist at Nomura International Plc. Still, there could be some positives of a Hunt win for markets. The new chancellor, and next Bank of England governor to replace Mark Carney after he steps down in January, would likely be “less exciting and more steady” under a Hunt government than under Johnson, he said.

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, Neil Chatterjee, William Shaw

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