Traders Think Even a Narrow Win Will Boost Pound

(Bloomberg) -- Follow @Brexit on Twitter, join our Facebook group and sign up to our Brexit Bulletin.

The pound could be set for a further rally if U.K. Prime Minister Theresa May avoids defeat in a confidence vote Wednesday, though a victory won’t end turmoil for the currency.

With sterling already climbing after the BBC reported May will get backing from enough Conservative Party lawmakers to see off the rebellion, traders believe even a narrow win is sufficient to give the beleaguered currency a reprieve. Yet investors still have to contend with a multitude of risks, including a vote on her Brexit deal or the prospect of another election and a second referendum.

The result of the no-confidence vote could come into the currency market’s so-called witching hour if it runs late. It’s due at 9 p.m. London time, but a delay could see it pushed between the end of the New York close and the start of trading in Tokyo, when thin liquidity could exaggerate any moves. Ahead of the vote, May told Conservative lawmakers that she won’t stand as their leader in the next election, according to three members of parliament who were in the room.

The pound was up around 1.3 percent at $1.2649 as of 5:58 p.m. in London. Here’s what banks see in store for the pound in the following scenarios:

If May Survives the Confidence Vote

  • Sterling should climb 1 to 2 percent on a trade-weighted basis if she survives, according to strategist Jordan Rochester at Nomura International Plc.
  • If May wins this vote, “and I still think there’s a good chance she may win,” expect to see a rally in sterling, but it will be limited by ongoing uncertainty, said head of currency strategy Jane Foley at Rabobank.
    • Even if the prime minister wins by a very slim majority she is unlikely to resign, added Foley.
    • However, the pound will rally more the bigger the majority for May, as “the market will probably assume that if she wins by a large margin she has a greater chance of getting her deal through parliament.”
  • The margin by which May wins the confidence vote doesn’t matter, said Ned Rumpeltin, head of foreign-exchange strategy at Toronto-Dominion Bank.
    • “A win’s a win. More votes the better, but this is going to very, very messy.”

If May Loses the Confidence Vote

  • Sterling could drop 3 percent on a trade-weighted basis within days if May loses the vote of confidence, said Nomura’s Rochester.
    • “The next 12 hours will be headline driven. If loyalists start a narrative about how we need a new direction, then that is very negative.”
  • The pound could eventually fall by 5 percent to 10 percent on a trade-weighted basis on capital flight should May lose the confidence vote and a hard Brexiteer takes over her position as prime minister, said John Normand, head of cross-asset strategy at JP Morgan Chase & Co.
    • “From there, the focus will be around potential capital flight or long-term hedging as opposed to the liquidation of investor positions by traditional asset managers or hedge funds.”
    • Normand said the bank’s base case is acceptance of May’s Brexit deal over the next few months, but confidence in this forecast is low.
  • A technical support level for the pound at $1.2310 should hold even if May loses the vote, said senior analyst Morten Helt at Danske Bank A/S.
    • “It looks like a strong technical level, and even though Brexit uncertainty will increase if she loses the vote, all options are still on the table. This should reduce damage to pound near term.”
    • The likelihood of a new referendum also increases with the scenario of May losing the leadership challenge, which would support the pound, Helt said.

©2018 Bloomberg L.P.