July 10, 2018 / 8:52 AM / 6 days ago

Sterling rebound fizzles but markets think PM May will fight on

LONDON (Reuters) - Sterling clawed back some of its recent losses on Tuesday as Prime Minister Theresa May sought to shore up her authority after two ministers quit over her hard-fought Brexit blueprint.

FILE PHOTO: New one pound coins come off the production line at The Royal Mint in Llantrisant, Wales, Britain, January 25, 2017. REUTERS/Rebecca Naden/File Photo

The pound’s gains were limited, however, after official gross domestic product data proved in line with forecasts and a stronger dollar weighed on the currency.

Markets had welcomed May’s official Brexit plans - unveiled on Friday - because they believe it makes a softer Brexit, in which Britain retains close trade ties with the European Union after its exit next year, more likely.

But the resignations of Foreign Secretary Boris Johnson and Brexit minister David Davis rattled May’s grip and stirred talk of a leadership challenge less than nine months before Britain is due to depart the EU. Sterling tumbled more than a cent.

On Tuesday the currency regained its poise, and moves were mostly muted.

“Either markets have been incredibly sanguine or stupid, or they are taking a view that there will be a solution,” said Savvas Savouri at hedge fund Toscafund Asset Management, which has $4 billion under management.

“The pound is basically telling us that there are so many checks in this that this is not the chaos it has been presented.”

Even if May is safe, the big question for markets is whether EU leaders will go along with her Brexit plans as a new round of negotiations begins later this month.

Analysts at Goldman Sachs said their baseline was that both the eurosceptics in the Conservative Party and the EU’s Brexit negotiators in Brussels would give May’s plan “the benefit of the doubt - for now.”

However, they said risks to that baseline had risen. Parliamentary arithmetic could frustrate May’s ability to win legislative approval for her plan and the EU may demand more concessions from Britain, angering pro-Brexit ministers.

Sterling rose to as high as $1.3301 - roughly where it was on Friday before the resignations - until the weaker data and rallying dollar knocked it back to $1.3273, 0.1 percent up the day.

Against the euro, sterling extended gains, spurred on by weakness in the common currency. The pound stood 0.3 percent stronger at 88.350 pence per euro.

POSITIONED FOR VOLATILITY

UK five-year credit default swaps, a form of insurance against debt default, stood at 24 basis points according to IHS Markit data, the highest level since May 29 though unchanged since Friday.

The internationally-exposed FTSE 100 share index edged higher. UK government bond yields rose after falling on Monday.

“We are now positioned with a small long position (on sterling), mainly via options, to take advantage of volatility in either direction,” said Marilyn Watson, Head of Global Fundamental Bond Product Strategy at BlackRock.

“The range of outcomes and tail risks on both sides (for a soft or hard Brexit) are now more extreme.”

Traders are also preparing for more British economic data that, if better than forecast, may heighten expectations of a Bank of England interest rate rise.

The improvement in data and upbeat comments from BoE Governor Mark Carney has lifted expectations of an August rate hike to more than 60 percent from less than 50 percent two weeks ago.

Additional reporting by Claire Milhench, Saikat Chatterjee and Maiya Keidan; Editing by Mark Heinrich

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