Pound Treads Near Multi-Month Lows vs. Euro and Dollar Amidst Fresh Political Intrigue

Brexit and the Pound

Image © Pound Sterling Live, Al Jazeera

- Conservative MPs lining up against 'no deal' Brexit

- But manoeuvres to thwart a 'no deal' Brexit no longer positive for Sterling

- Survey shows only 4% of CFOs think now is a good time to take on risk

The British Pound is trading towards the lower end of multi-month ranges against both the Euro and U.S. Dollar as a new week of trade that should be dominated by ongoing political intrigue commences.

The Pound-to-Euro exchange rate is quoted at 1.1154, marginally higher than the July low which is at 1.1121. The Pound-to-Dollar exchange rate is quoted at 1.2527, the July low is at 1.2481, a level triggered on Friday.

Undermining confidence in the UK currency is the growing prospect of a General Election taking place before the year is out, with expectations for another poll only growing this Monday amidst a flurry of reports that the next Prime Minister's attempts to deliver a 'Brexit at all costs' by October 31 will be be blocked by his own party.

The Times reports "dozens of Conservative MPs" are "plotting" to stop the next Prime Minister delivering a 'no deal' Brexit should his attempts to reach a new accord with Brussels fail.

Both contenders to replace Prime Minister Theresa May have made firm commitments to leave the EU in as short a time period as possible, with Boris Johnson making leaving the EU on October 31 a "do or die" pledge and Jeremy Hunt saying that if no fresh deal is reached with Brussels by the end of September he will prepare to leave without a deal.

It is however becoming increasingly clear that members of the Conservative party would seek to stop such a pledge.

Justice Secretary David Gauke is one such Government minister willing to resign his position if the next prime minister chooses to pursue a no-deal Brexit.

Gauke told the BBC's Andrew Marr Show that a "sizeable" number of Conservative MPs believed the UK should leave with a deal. "Given where the parliamentary majority is and the strength of feeling on a no-deal Brexit, I think there probably will be a parliamentary way in which this can be stopped," Gauke said.

Conservative MP Sam Gyimah said more than 30 of his party's MPs could vote against a 'no deal' Brexit adding that there were various plans being considered to prevent such an outcome.

Now, in the past the Pound has risen on the presumption that Parliament can block a 'no deal' owing to a simple 'no deal' = bad for the Pound mentality in the market. Therefore, the headlines that Parliament will conceivably block a 'no deal' should be good for Sterling.

But this dynamic probably no longer applies: we believe this time around is different as any stance that ultimately continues to block the delivery of Brexit only hastens the onset of a General Election which will be seen as the only realistic means to break the chronic Parliamentary deadlock.

And a General Election should invite further declines in the value of Sterling as it poses substantial political uncertainty.

Simon Derrick, currency strategist with BNY Mellon says Sterling tends to exhibit substantial volatility heading into elections:

"The volatility seen in 2010 (at a time when the main parties were essentially vying for the center ground of UK politics) highlights perfectly GBP’s dislike of political uncertainty running into a general election. That period saw realized volatility in EUR/GBP and GBP/USD reach levels that have only subsequently been breached in the months immediately following the 2016 referendum. In light of this it seems reasonable to assume that concerns driven by political uncertainty could prove at least as elevated this time around."

The uncertainty posed by both a 'no deal' Brexit and a snap General Election would weigh on Sterling we believe.

The stance being adopted by 'Remainer' Conservative MPs is problematic from another perspective: both Hunt and Johnson know that in order to be taken seriously on any potential renegotiations they need Brussels to believe they are committed to pursuing a 'no deal' Brexit which is an outcome that also poses significant challenges to the EU.

Johnson said on the weekend he would make Brussels “look in our eyes” and believe that Britain was prepared to leave without an agreement.

However, Brussels will take note of developments that see Conservative MPs willing to block their own Prime Minister's agenda and calculate that simply refusing to renegotiate could trigger a General Election which could would in turn raise the odds of a new Government being installed that would grant a second EU referendum.

"We continue to think a 2nd referendum is the most likely course of action with a delay in Brexit possibly until around the middle of 2020 to allow time for a vote," says Derek Halpenny, Head of Research at MUFG. "We maintain that parliament will continue to have the ability to thwart the UK leaving on the 31st October with no deal. However, the current stance of Boris Johnson suggests he will try to do exactly that, at least for an initial period."

So at this juncture, signalling that a 'no deal' will be blocked only diminishes the prospects of any realistic alternative being presented to Parliament while raising political uncertainties.

"With Parliament unable to agree on the next step forward, our economics team believes that the risks of a general election have materially risen," says Kamal Sharma, FX Strategist with Bank of America Merrill Lynch Global Research. Sharma says he sees an election prompting a spike in volatility in the British Pound exchange rate complex.

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Economy is Latest Concern for Sterling as CFOs Cut Back Investment Intentions

Meanwhile, the economy continues to evolve in a direction that is unsupportive of Sterling with news out on Monday that business sentiment amongst the financial directors of the UK's largest firms has plummeted to levels last seen in the financial crisis of 2008.

According to the latest Deloitte CFO Survey, "a more challenging environment is weighing on the corporate sector with risk appetite among UK Chief Financial Officers falling to the lowest level since the failure of Lehman Brothers in 2008."

The CFOs believed that leaving the EU would hurt Britain's long-term business environment. "Brexit has not happened, but it is acting as a
drag on corporate sentiment and spending. 62% of CFOs expect to reduce hiring in the next three years because of Brexit and 47% expect to reduce capital spending," says Deloitte.

Only 4% said it was a good time to take on more balance sheet risk, the lowest percentage since the collapse of Lehman Brothers in 2008 which helped trigger the financial crisis.

CFO risk appetite

Image courtesy of Deloitte

CFOs are central to driving investment by corporate Britain, after all they control 'the purse strings' and the survey therefore suggests to us business investment in the economy will continue to fade and stifle performance as 'risk taking' is reduced.

Indeed, the findings from Deloitte follow on from last weeks PMI surveys that showed the UK economy likely shrank in the second quarter.

The UK's economic trajectory is therefore increasingly becoming a negative one and it could well result in the market betting the Bank of England will be tempted into cutting interest rates in coming months,

A currency tends to fall when its issuing central bank cuts, or signals it will cut, interest rates.

A robust UK economy has for some time been a source of support for Sterling in the face of the chaotic political climate, but it appears this leg of support is now weakening and is providing yet another reason to be bearish on Sterling.

Last week the Pound fell on comments made by Bank of England Governor Mark Carney that risks to the outlook for both the UK and global economy were becoming increasingly elevated.

Markets interpreted his speech, delivered in Bournemouth on Tuesday, July 02 as reason to increase bets that an interest rate cut would be forthcoming which helped push the Pound towards the bottom of long-term ranges against the Dollar and Euro.

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