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Pound path grows hazier as political tremors add to Brexit woes

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Theresa May's decision to step down as Britain's prime minister just made the bruised pound's outlook even murkier.

[LONDON] Theresa May's decision to step down as Britain's prime minister just made the bruised pound's outlook even murkier.

The uncertainty around Brexit is now substantially higher given traders have to contend with what the new leader's stance would mean for the nature of the divorce. The pound has seen a record-long losing streak against the euro this month, weighed down by fears that a pro-Brexit premier, such as current favorite Boris Johnson, could pull Britain out of the European Union without a deal, an outcome long seen as the worst-case outcome for markets.

Still, sterling's stability after Mrs May's resignation is a sign that a disorderly Brexit isn't a foregone conclusion, according to Lars Merklin, a strategist at Danske Bank A/S. He expects the UK currency to remain stuck round these levels while markets try to digest the results of the ongoing EU parliamentary elections and decipher the various likely Brexit scenarios.

"It's really a game of probabilities versus where the pound is today," Mr Merklin said. "Next up is to figure out how moderate Boris Johnson truly will be, if he wins, and if the math to get something done in either direction of Brexit has changed. The time it takes to figure all that out implies sterling will consolidate over the coming month."

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The pound was little changed Friday at 88.35 pence per euro, halting a more than 3.5 per cent slide since May 3. Against the dollar, sterling was at $1.2661 and on track for its third weekly decline. UK gilts were little changed, with the 10-year yield having earlier touched 0.945 per cent, the lowest since mid-2017.

A big win on Sunday in the European parliamentary elections for Nigel Farage's Brexit Party, which supports a no-deal departure, would put pressure on whoever succeeds Mrs May to appeal to those looking to leave the bloc. Mr Johnson, a top contender to take over from Mrs May, said Friday that he believes the UK will leave the EU on October 31 - the latest deadline - with or without a deal.

With risks on the horizon now ranging wide - from a chaotic withdrawal from the EU to an early UK election and or even no Brexit at all - traders are refraining from going all out to hedge against pound swings. That is apparent from the fact that sterling's implied volatility remains relatively subdued. The six-month measure, which covers the October 31 exit deadline, is still well below highs seen at the start of this year.

UBS Global Wealth Management now sees an increasing chance of a further extension to the Brexit deadline, which could lead to a snap election or another referendum. They recommended that global investors with exposure to UK assets buy protection against adverse market swings.

"We have long recommended such investors consider hedging to protect against further sterling weakness; we think it is too early to unwind these hedges," said Mark Haefele, chief investment officer at UBS Wealth. "We now see a rising chance that the UK will be compelled to ask the EU for a further delay to Brexit."

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