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Pound Sterling Snaps Losing Streak on May's Exit Announcement, Gains Forecast to be Short-Lived

May exit strategy

Above: Prime Minister May announces she is to step down on June 07. Image (C) Pound Sterling Live

- GBP/USD: 1.2680 -0.20% on the week | GBP/EUR: 1.1341 -0.50% on the week

- May lays out exit timeline

- Conservative leadership campaign tipped to start June 10

- Sterling could see near-term relief, but tough summer ahead

Pound Sterling snapped a record losing streak against the Euro and Dollar on the day UK Prime Minister Theresa May announced she would be resigning from office. 

May will resign on Friday, June 07. 

In an emotional statement delivered outside 10 Downing Street Maye said she had done her best to deliver Brexit and it was a matter of "deep regret" that she had been unable to do so. May will continue to serve as Prime Minister while a Conservative leadership contest took place.

May set out a timeline for her exit following a meeting with Sir Graham Brady, the Chairman of the Conservative Party's 1922 Committee.

The resignation was highly-anticipated and therefore the Pound will have priced in the event over recent days. We wrote on Thursday that the Pound could actually go higher on a resignation announcement, and indeed this is a call that played out nicely.

Why would the Pound go higher on a resignation? Simply because some clarity on the next steps in the UK political process are made clear: currencies dislike uncertainty and the removal of any kind of uncertainty typically is met by a relief rally.

Add to this the UK currency was looking heavily oversold on short-term timeframes and we get the perfect conditions for a snap higher.

The resignation marks the high water point of a frantic three weeks in British politics: Sterling has been under pressure since early May as it became increasingly clear a political shake-out was imminent and that it would not be Theresa May who was in charge of the country on October 31, the day the UK is set to leave the EU.

"The resignation of Prime Minister Theresa May supports our recent view that the chances of a Brexit deal have fallen and that the chances of another delay and a no deal Brexit have risen. While the financial markets have probably already priced this in, with concerns over the global economy also rising, we believe that the downside risks to the Pound (even though it initially rose on the news) and gilt yields are growing," says Paul Dales, Chief UK Economist with Capital Economics.

On the back of growing political uncertainty the Pound-to-Euro exchange rate has fallen from 1.1776 down to current levels of 1.1333 in an uninterrupted run of 14 consecutive days of losses: a record for the pair.

The Pound-to-Dollar exchange rate meanwhile fell from highs at 1.3177 in early May down to current levels of 1.2674.

 

Where Next for Sterling?

We consider the Pound's outlook from two perspectives: the short-term, which covers coming days, and perhaps the next week or two, and the medium-term, which covers the summer period.

Our suspicion is that in the near-term we could finally see the selling pressures on Sterling relent, purely because by setting out a departure timeline May will have provided markets with some degree of certainty on the way forward.

"Provided that Theresa May leaves as quickly as possible, the Pound could see some sort of recovery near-term," says Marc-André Fongern, a strategist with MAF Global Forex in Frankfurt. "It would be advisable to await the state of affairs before adopting a new attitude towards the Pound ... we are slightly positive that the currency can pick up some momentum once Theresa May has resigned. At least for a short time!"

It is not entirely unconceivable that the market adopts a wait-and-see approach to the Pound once May has announced her departure. Looking back at Sterling's performance since the 2016 referendum, the Pound tends to enter into stubborn sideways trends in such an environment, particularly against the Euro.

We would not be surprised to see a few days, or weeks even, of sideways action, particularly against the Euro.

But the currency must of course find a floor first: and suggesting we are at the floor now is too hard to say.

Indeed, looking at the medium-term timeframe, further downside for Sterling is likely as markets will likely be spooked by the rhetoric coming from the Conservative Party leadership contenders, all of which will almost certainly strike a robust tone on Brexit.

"We think Conservative leadership elections are likely to extend pressure on Sterling. While it should be partly priced in by now that a Brexiteer will likely follow Theresa May as prime minister, a change that would increase the risk of a no-deal Brexit, we expect headline risk to increase nervousness among investors and lead to a rise in volatility," says Kathrin Goretzki, CFA, FX Strategist with UniCredit Bank in London.

Pound to euro's poor run

Above: Sterling's decline vs. the Euro.

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What Boris Johnson, the current favourite, says will be of particular interest to markets.

"The bookies favourite Boris Johnson may appeal for some, yet for markets the prospect of a bumbling Brexiteer does not look enticing. The chances of no-deal Brexit or a general election both rise with May’s resignation, and looking at the Pound this week, markets certainly know that," says Joshua Mahony, Senior Market Analyst at IG.

The overall trend in Sterling remains lower and with a summer of jostling amongst Conservative politicians for the top job we would expect the potential for further declines.

"The temptation to support a leader who has expressed a willingness to consider a 'no deal' Brexit could be strengthened by the strong public support for Nigel Farage's new Brexit party," says Mark Haefele, Global Chief Investment Officer GWM at UBS. "Investors should not be complacent about the threat of a 'no deal' exit."

UBS believe a 'no deal' would take the Pound as low as 1.15 vs. the Dollar and 1.03 vs the Euro.

Johnson's campaign for the leadership has gathered steam this week and the ex-mayor of London now has the public backing of at least 10 MPs including Jacob Rees-Mogg, the chair of the European Research Group, Zac Goldsmith, the former London mayoral candidate, and John Whittingdale, the former culture secretary.

Johnson gained the backing of two more significant endorsements on Thursday after Johnny Mercer, who had been considered a leadership hopeful himself, and Gavin Williamson, the former defence secretary who sees himself as something of a 'king maker', made public their support.

The new Prime Minister will inherit an unresolved Brexit, and a looming deadline in the form of the October 31 exit date that should heap pressure on the fledgling administration.

Of course, the new leader is by no means guaranteed a parliamentary majority as some 'remainer' MPs could choose to quit rather than serve under a Prime Minister who would consider a 'no deal'.

It is widely expected that the next Prime Minister would look to reopen negotiations with Europe, and should this fail, opt for a 'managed no deal' Brexit.

Therefore a General Election and a Corbyn administration cannot be ruled out before 2019 ends.

"Our longstanding position has been that some combination of a 'no deal' Brexit and/or early elections will continue to weigh on the GBP, so we continue to expect a political risk discount to remain embedded in the currency," says Stephen Gallo, foreign exchange strategist with BMO Capital.

BMO Capital forecast Sterling to be at 1.22 against the Dollar and 1.11 vs. the Euro in six months.

 

Next Steps in Choosing a New Prime Minister

The gates are now open for potential replacements to set up stall and we expect a robust stance on Europe to keep currency traders shy on Sterling: we get the sense that there is further potential for 'no deal' Brexit odds to increase.

The next steps to selecting a new leader will firstly see Conservative MPs nominate their preferred candidates, with nominations closing in the week of June 10.

What follows is a successive rounds of votes that will whittle the field down to two, this should be completed by around the end of June.

Hustings with local Conservative associations around the UK then take place ahead of a vote.

The party membership will then deliver a result ahead of the summer break and a new Prime Minister should be in place by mid-July.

BannerTime to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.

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