By Tommy Wilkes
LONDON (Reuters) - Sterling slid on Monday after the resignation of the British foreign minister heaped pressure on Prime Minister Theresa May, but its losses were expected to be contained unless a full-blown leadership challenge materialized.
Boris Johnson followed Brexit minister David Davis in resigning in opposition to May's hard-fought blueprint for how Britain is to structure its relationship with the European Union after its leaves the bloc in March.
That plan - announced on Friday - has been welcomed by markets, which believe it made the "soft Brexit" favored by businesses and investors more likely.
Sterling had traded higher before Johnson's resignation as investors speculated May would find it easier to negotiate with Brussels without opponents to her vision of Brexit inside her cabinet.
"The danger is that PM May faces a no-confidence vote and the risk has grown that we will have a leadership challenge and a possible hard Brexit leadership facing the EU," said Kenneth Broux, FX strategist at Societe Generale (PA:SOGN).
The British currency fell half a cent to as low as $1.3259
Sterling slid 0.3 percent versus the euro to 88.625 pence per euro
Under May's Brexit plan, Britain and the EU would retain close trade ties. But Davis said he believed this would hand too much power to Brussels in the exit talks.
While Davis has said he would not seek to challenge May's leadership, Johnson's ambitions appear less clear.
"What we can say is the pound can handle ministerial resignations if that's the extent of it...if it means Johnson leaving and not launching a leadership challenge," said Viraj Patel, an FX strategist at ING.
UK stocks, which benefit from sterling weakness, rose 0.9 percent (FTSE).
NO DISCIPLINE
The resignations have underlined May's limited ability to impose cabinet discipline around a softer Brexit strategy.
But analysts said May's success in getting broad agreement for her plan for life after the EU was important, reflecting sterling's relatively muted moves on Monday.
Under the agreement announced by May on Friday, Britain will retain a close trading relationship with the EU, making the sort of arrangement business leaders have called for in recent weeks more likely.
"It's a softer Brexit and it's a plan. A plan is better than no plan. The market is extrapolating that the EU will get more concessions out of the UK", bringing the two sides toward something like a customs union as favored by markets, Nomura analyst Jordan Rochester said.
May named Brexit campaigner Dominic Raab as Davis's replacement.
Broad-based dollar weakness also supported the pound's bounce, while data this week could raise expectations of a Bank of England interest rate rise in August if it suggest growing economic momentum in the second quarter.
Markets are pricing in a 62 percent chance of a rate rise in August, down from 69 percent before Johnson quit. Ten-year British government bond yields slipped after news of Johnson's resignation (GB10YT=RR).
Sterling has climbed around 2 percent since hitting a 7-1/2 month low in late June, boosted by improving economic sentiment and signs that May had faced down the hard Brexiteers in her cabinet.