February 20, 2019 / 9:53 AM / in 2 months

Sterling weakens after UK lawmakers quit PM May's party over Brexit

LONDON (Reuters) - Sterling weakened on Wednesday after three lawmakers defected from Prime Minister Theresa May’s ruling Conservative party in a move that could undermine her Brexit strategy.

FILE PHOTO: British Pound Sterling banknotes are seen at the Money Service Austria company's headquarters in Vienna, Austria, November 16, 2017. REUTERS/Leonhard Foeger

May has returned to Brussels to try to salvage her Brexit deal which was voted down by Britain’s divided parliament last month.

But the decision by three pro-EU lawmakers to quit their party over what they called the government’s “disastrous handling of Brexit” cast fresh doubt over her ability to get any EU-UK deal approved, and that weighed on the pound.

The British currency fell to the day’s low of $1.3012 after the resignations and was down as much as 0.4 percent on the day before recovering on comments by Spain’s foreign minister to Bloomberg that a deal was in the process of being “hammered out.”

Analysts said the defections had pressured the pound by reducing the government’s working majority in parliament and had increased the possibility of a snap election.

“An early election would presumably be fought under a different Conservative leader (May has committed not to fight the next election) and likely under a more Eurosceptic one,” said Adam Cole, chief currency strategist at RBC Capital Markets.

“It is hard to argue either an election victory for a more Eurosceptic Tory party, or a Labour-led government would be anything other than negative for GBP,” he added.

If May cannot persuade European Commission chief Jean-Claude Juncker or the British parliament to modify her deal, Britain could crash out of the world’s biggest trading block in 37 days.

Sterling ups and downs on Brexit: tmsnrt.rs/2Eji7wm

The main hurdle is the so-called backstop, an insurance policy to prevent the return of extensive checks on the border between European Union member Ireland and the British province of Northern Ireland. Uncertainty over those arrangements is weighing on the pound.

Sterling surged above $1.3 on Tuesday in its biggest daily gain of the year against the dollar, partly on hopes of a breakthrough in the Brexit impasse.

But traders said those bets had been misplaced.

“I think they [the EU] could tinker with the language [of the deal] a bit, but whether it would be enough to convince 51 percent of MPs in parliament to vote for it is dubious,” said ACLS Global chief strategist Marshall Gittler.

“I’d go short on the pound,” he added.

Recent wild swings in the pound have underlined the currency’s volatile nature ahead of Brexit.

Investors are skittish because May has yet to win parliamentary support for her deal six weeks before Britain is due to leave and options markets show jitters remain about the March 29 deadline.

Derivative markets were cautious, with two-month pound risk reversals, a gauge of calls to puts on the British currency, hovering near three-month lows.

That is a sign of investor caution about the pound’s outlook in the near-term.

Pressure on May to end the uncertainty for business has increased after Honda’s decision this week to close its British car manufacturing plant.

Two-month implied vol rises more than one-month vol: tmsnrt.rs/2BM1pnI

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

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

Reporting by Tom Finn, Editing by Jane Merriman, Alexandra Hudson, William Maclean

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