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Sterling Faces Deeper Losses May's 'New Deal' is Rejected

May addresses media

Image: Prime Minister Theresa May, File Photo © Number 10 Downing Street

- Snapshot: GBP/EUR: 1.1327 -0.48% | GBP/USD: 1.2648 -0.47%

- Theresa May offers 'new deal' on Brexit

- Response by MPs suggest it will not get through Parliament

- Market to rebuild GBP "short positions" say MUFG, Capital Economics.

The Pound is trading lower in mid-week trade amidst speculation Prime Minister Theresa May could be forced out of office over coming days.

Reports suggest senior Cabinet ministers are looking to call on the Prime Minister to resign as soon as possible, as it becomes clear there is virtually no support for her new Brexit deal to pass through Parliament.

"Rumours - not yet confirmed, but equally not being denied - of a move against PM by cabinet today. Source says it’s looking likely," reports ITV's Paul Brand.

The Evening Standard reports Cabinet ministers were this afternoon discussing sending a delegation to tell Theresa May she should resign after botching her “last chance” at a Brexit deal.

It is said at least four ministers were said to be in talks about calling time on the Prime Minister after her attempt to get cross-party backing for a new plan hit a wall of opposition.

"What could be viewed as best from a sentiment perspective and for the Pound, would be for PM May to resign now and not waste the next two weeks on a deal that stands next to no chance of passing," says Derek Halpenny, a foreign exchange analyst at MUFG in London. "If May continues to pursue this deal and with ample scope for the market to re-price no-deal risks later this year and general election risks, we see scope for further GBP declines from here over the short-term."

The declines in the Pound extend a negative trend that has been in place through the course of May and we hear today the currency is at risk of further steep losses during the summer months.

The forecast that further declines in the currency are likely come from a number of foreign exchange analysts who are today responding to the recent flaring of domestic political uncertainty and growing market fears of a 'no deal' Brexit on October 31 which was accentuated by the political reaction to Prime Minister Theresa May's latest 'new deal' offer to parlament. 

May said Tuesday that she'll put her EU Withdrawal Agreement Bill (WAB) before parliament again in the week of June 03, but this time around it'll include overtures to the opposition Labour Party in an attempt to form a cross-party consensus in Parliament.

Amongst the overtures are a Parliamentary vote on whether a confirmatory referendum on her deal should be held if it is passed. 

MPs in the House of Commons will also be given an opportunity to dictate the kind of future customs relationship the country seeks to have with the EU following a scheduled October 31 exit. 

Sterling initially rallied on news of a potential referendum, however, the scale of the opposition to the 'new deal' was soon revealed to be sizeable.

Sterling relinquished its gains: the Pound-to-Euro exchange rate rallied to a best of 1.1455 before paring those gains to quote at 1.1398 mid-week. The Pound-to-Dollar exchange rate went as high as 1.2756 before retreating back to 1.2714.

"As the new Brexit deadline approaches, we think that investors will rebuild short positions in Sterling, putting renewed downward pressure on the currency," says Jonas Goltermann at Capital Economics.

According to trader Neil Jones with Mizuho Bank in London, Sterling "has totally factored out chances of a referendum 2 and we may not even see a Meaningful Vote 4".

He sees no "game changer in the mix" for Sterling after Prime Minister May's statement.

"Personally, I suggest chances of no deal is nearer 50 % given the way things are shaping up right now," says Jones who is looking for the trend lower in Sterling to continue into the EU elections "and beyond."

Above: GBP's rolling one-week performance vs G10. Monday, 20 May. Source: Pound Sterling Live.

May's move was an attempt to lure votes from opposition Labour Party MPs whose party has consistently advocated in favour of a customs union and form of single market membership in recent months.

However, there's a significant risk the PM will simply lose more votes from her own MPs than she is able to gain from the opposition, which would likely consign her 'new deal' to the dustbin and lead to another controversial choice for MPs.

That choice would be between abandoning Brexit via the revocation of Article 50, a second referendum, a snap election and pursuing a 'no deal' exit that sees the UK default to doing business with the EU on World Trade Organization (WTO) terms.

"We still believe that there is scope for the Pound to weaken further over the summer," says Lee Hardman, an analyst at MUFG in London.

PM May's entreaty to opposition politicians came just two days ahead of European parliament elections which are touted by opinion polls as likely to see the governing Conservative Party receive a drubbing of historic proportions. 

Some polls have shown support for the Conservative Party falling to a single digit number, while Nigel Farage's new Brexit Party is riding high at the top of the polls after claiming first place in all of them. The opposition has lost support to, polls show, and combined support for the two main parties is now at the lowest level ever recorded.  

Above: EU election opinion poll-of-polls. Source: MUFG.

"Downward pressure on the pound could intensify if market participants become more fearful that a heightened domestic political uncertainty could increase the risk of a “No Deal” Brexit at the end of October. It could result in a further 3-4% decline for the pound," says MUFG's Hardman. 

This is feeding concerns in some quarters that the resulting fragmentation of the political landscape could put opposition leader Jeremy Corbyn into 10 Downing Street, with potentially adverse consequences for the public purse and economy, if an election is called.

However, even if the mess in Westminster doesn't put the opposition into office it could still fragment the political landscape and lead to increased levels of uncertainty on a long-term basis, which would be bad for Sterling. 

Above: Pound-to-Euro rate shown at daily intervals.

"The more immediate concerns of market participants will likely continue to focus more on the higher “No Deal” Brexit risk rather than the rising probability that Brexit may not be implemented. It supports our view that risks are more skewed to the downside for the Pound heading into the summer," Hardman says. 

MUFG forecasts the Pound-to-Euro rate to decline to 1.0867 before October 31 if markets begin to suspect that a 'no deal' exit is genuinely in the pipeline, and many analysts have said the exchange rate could head toward parity in the event of an actual WTO exit.

Currency markets dislike Brexit because investors and analysts believe it will harm the economy in the short-term and lead to slower economic growth over the long-term which would mean future interest rates are likely to be lower than they otherwise might have been. 

Interest rate decisions impact currencies through the push and pull influence they have over international capital flows, with rising rates normally drawing a bid for a currency and declining rates normally driving flows away from a currency. 

"If an orderly Brexit is agreed in late October, we project that the [Pound-Dollar] exchange rate will end this year at $1.25. And in the less likely event of a no-deal Brexit, we suspect that it would plunge to $1.15," says Capital Economics' Goltermann. 

Above: Pound-to-Dollar rate shown at weekly intervals.

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