LONDON (Reuters) - Sterling’s fortunes, hostage to Brexit news for more than two years, now hinge on whether Prime Minister Theresa May’s exit agreement with the EU can get through parliament on Dec. 11.
The odds look stacked against May, and a defeat for her could open up a raft of potential outcomes for Britain’s scheduled departure from the European Union, and for the pound, which is among the worst performing major currencies of 2018.
Sterling is trading around $1.27 GBP=D3 but with most observers still expecting some kind of deal to be reached eventually, polls forecast it will firm to $1.29 in a month and $1.34 in six months.
Still, fears of a no-deal Brexit skewering Britain’s economy in less than four months’ time are reflected in heightened volatility and outright short positions held by hedge funds.
Below are five scenarios that could arise from Tuesday’s vote, and possible market reactions:
The chances of parliament ratifying the agreement are slim — 30 percent, according to MUFG analysts — but if May does pull it off, the currency would rally 3 percent to $1.30, according to Gavin Friend, a strategist at NAB in London.
It may rally further to $1.38 in early 2019 if optimism builds for frictionless trade between Britain and the EU, he reckons.
Goldman Sachs shares that view of a 3 percent sterling bounce while the median forecast by currency strategists polled by Reuters was for 3.5 percent gains if members of Parliament agree to the deal.
A narrow defeat for May - say by around 20-50 votes - is seen by investors as the most likely outcome.
The Reuters poll predicted a 2.75 percent fall in the currency should the vote fail to pass.
Against the euro, sterling could tumble 2 percent, says John Marley, a currency consultant at risk management specialist, SmartCurrencyBusiness who sees a loss in the 2-4 percent range against the dollar.
This is the scenario that has potential to cause most short-term volatility for the pound and will heighten its risk premium as May is forced to ask Brussels to renegotiate, Marley says.
But a narrow defeat leading to a second, successful, vote in parliament, possibly in early January, would send the pound surging, taking it around 5 percent higher than current levels, according to Goldman Sachs analyst George Cole.
First though, a narrow defeat on Tuesday will trigger a knee-jerk 1-2 percent sterling fall, he cautions.
An emphatic defeat for May by a margin of around 100 votes leaves her withdrawal agreement in tatters and propels sterling into the unknown.
Such a conclusive thumbs-down could convince markets that Britain is heading inescapably towards a no-deal Brexit and will push sterling below $1.20, Oliver Brennan, a strategist at TS Lombard predicts.
Markets will then start to weigh up whether May’s party will topple her or if she will lose a no-confidence vote. If no government can prove it commands a majority 14 days later, this would force a general election and could lead to a second referendum.
The Reuters poll forecast a 2.75 percent fall in sterling if the deal does not pass but did not specify the margin of loss.
A snap election announcement could hasten an even more chaotic period in UK politics and create significant volatility in the pound.
Kenneth Broux, a strategist at Societe Generale, expects sterling to trade close to $1.20 if not below, and to slip towards parity against the euro, if new elections are called.
A snap election call would trigger a bigger sterling tumble against the euro because it would hurt the single currency far less than a no-deal Brexit, which would probably hit both currencies in more equal measure, Broux said.
Some forecasters are more pessimistic. An election that sees Labour under veteran left-winger Jeremy Corbyn in with a good chance of victory could push sterling 10-15 percent lower, and even possibly as much as 20 percent, NAB’s Friend says.
Gilt yields could also surge on concerns about the Labour Party’s unfunded spending promises, he added.
Such a currency move sounds extreme but Saxo Bank agrees, predicting it to fall all the way to parity with the dollar, a move of over 20 percent, if Corbyn looks likely to win
5/ SECOND REFERENDUM - LET’S VOTE AGAIN
If momentum gathers for a second referendum, TS Lombard’s Brennan sees the pound rallying to $1.30.
Such a referendum could conceivably have various outcomes, ranging from remaining in the EU to crashing out with no deal.
If it brings about May’s deal or a similar one involving close ties to the EU, BNP Paribas SA said this would also boost the pound.
The idea of a second referendum has been gathering support from some senior British politicians and now seems to have traction with sections of public opinion.
Reporting by Tom Finn and Saikat Chatterjee; Editing by Sujata Rao and Kevin Liffey