June 25, 2019 / 8:35 AM / 4 months ago

Tentative pound rise capped as PM candidate Johnson says he is "serious" on no-deal Brexit

* Traders sit on sidelines amid UK leadership race

* Pound near one-month high vs dollar but gains capped

* Graphic: World FX rates in 2019 tmsnrt.rs/2egbfVh

* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv

By Tommy Wilkes

LONDON, June 25 (Reuters) - Dollar weakness allowed the pound to briefly scale a one-month high on Tuesday, although the risk of no-deal Brexit stemming from the Conservative Party leadership contest kept the currency hemmed into a narrow trading range.

Sterling has been supported to some extent by last week’s Bank of England meeting which sounded less dovish than other central banks; the dollar has lapsed to three-month lows to the euro and five-month lows versus the yen after the Federal Reserve encouraged expectations of a July rate cut.

Against the euro too, sterling inched higher off the near-five-month lows hit in the previous session .

Markets are increasingly concerned that the favourite to replace Prime Minister Theresa May — the eurosceptic Boris Johnson — will take Britain out of the European Union with no transition trading agreements in place, a scenario many warn would be catastrophic for the economy

Johnson reiterated his stance, telling the BBC he was “serious” about leading Britain out of the EU on the Oct. 31 deadline without a deal if the bloc refused his demands to negotiate a new exit agreement.

“The market has become more alert to no-deal risk. If we go back a few months that risk had been almost eliminated but it has re-emerged,” said Sarah Hewin, chief Europe economist at Standard Chartered.

She added that while no-deal did not still appear to be the main scenario for markets, “having a front-runner who has clearly stated no-deal is an option, is a concern.”

By 0800 GMT, the pound was up 0.16% at $1.2760, coming off a one-month high of $1.2784 while against the euro, it was a quarter percent higher at 89.25 pence

The new leader will be elected by the end of July, leaving only a few months for any new prime minister to try to renegotiate a Brexit withdrawal agreement with Brussels before the Oct. 31 date.

These concerns are preventing sterling from benefiting from the dovish stance of central banks almost everywhere else in the developed world.

Scotiabank analysts saw sterling capped “in the upper $1.27s” against the dollar, predicting it to lag a broader dollar decline.

CFTC data at the end of last week showed that speculative investors such as hedge funds had cut their “net sterling shorts” by $563 million, though they remained heavily short the pound.

Sterling implied volatility remains low, though one-month vol picked up to two-week highs at 6.6 vols. Six-month vol, encompassing the Oct. 31 period, is also at two-week highs though it has risen sharply since since mid-April when it fell below 7 to touch the lowest levels in over a year. (Reporting by Sujata Rao Editing by Keith Weir)

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