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Pound investors fear currency slide if May leadership challenged


[LONDON] It's not just Theresa May who's worried about being toppled.

Pound investors say the resurgent threat of Conservative party turmoil is one more reason to avoid the UK currency. Amid reports that the British Prime Minister faces ministerial resignations if she fails to achieve a solution to a Brexit deadlock, strategists warn sterling could fall as low as US$1.25 if she is ousted in a leadership challenge.

"The risk appears to have increased as the government is moving closer to making tough decisions on Brexit which could prove divisive," said Lee Hardman, a currency strategist at MUFG. "The lack of progress appears to have resulted in the market pricing in a higher risk premium into the pound."

Ahead of Mrs May's cabinet meeting on Friday, Brexit Secretary David Davis has reportedly rejected attempts at a compromise over customs arrangements and Chancellor Angela Merkel's government is also said to be unconvinced by the proposal. That news erased gains made by the pound earlier on Thursday after comments by Bank of England (BOE) Governor Mark Carney.

MUFG isn't the only bank preparing for the worst. Mizuho Bank Ltd.'s head of hedge fund sales, Neil Jones, sees the likelihood of an attempted ouster at 50 per cent - which would cause the UK currency to drop to at least US$1.30. Rabobank's head of currency strategy Jane Foley sees it as a "perennial threat" but one which could come to a head this weekend.

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BOE Path

With clarity on Brexit still proving elusive, the market also has to contend with the BOE's policy path. Carney may have struck an upbeat tone Thursday, saying he had "greater confidence" in the UK economy, but the Brexit outcome could be a swing factor for the central bank's outlook.

The lack of visibility around both key drivers "may just reinforce a lack of desire to engage with sterling," according to TD Securities' head of European currency strategy Ned Rumpeltin. Options show the market has been bearish on the pound for months, and the trend shows no sign of reversing.

Allianz Global Investors is short sterling, said Kacper Brzezniak, a fixed-income money manager. JP Morgan Asset Management's global market strategist Mike Bell said on Thursday that the bank had a small long position on the pound but that it was avoiding placing a big bet ahead of the gathering at the prime minister's country retreat.

If Mrs May manages to unite her cabinet behind a Brexit strategy which is also palatable to the European Union, sterling could see a short-covering rally up to US$1.34, according to Kenneth Broux, a strategist at Societe Generale SA.

On the other hand, under a worst-case scenario in which the prime minister is ousted by ardent Brexiteers and replaced with a hard Brexit candidate, sterling would fall to as low as US$1.25, said Mizuho's Jones.


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