(Bloomberg) -- As if the drawn-out Brexit uncertainty wasn’t enough, the pound is now at risk from the battle over the U.K.’s leadership.
Investors are watching for signs whether a much-anticipated challenge to U.K. Prime Minister Theresa May will actually materialize, and the outcome of a meeting of Conservative Party backbenchers Wednesday could be crucial. Long-time sterling bull Nomura International Plc switched to a neutral stance Monday, recommending a flat position amid reports of mounting opposition to May from within her own party.
While sterling gained Tuesday on optimism the European Union is preparing to offer a solution for the Irish border issue, political risk could yet set the currency back, according to Credit Agricole (PA:CAGR) SA and Nomura. The prospect of a leadership threat has reappeared on traders’ radar since the weekend press reported that the number of lawmakers rallying against May was approaching the number required to officially mount a challenge.
“Any indication that political risks are on the rise in Westminster could fuel fears about a ‘no-deal’ Brexit and sink the pound,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole. “While we still hope for a last-minute Brexit deal, we maintain a rather cautious stance on the pound for now.”
The pound slid 0.6 percent last week as a key EU summit failed to yield much progress on Brexit. Option market sentiment on the sterling-dollar pair has turned more bearish, with risk-reversals on the one-year tenor hitting the lowest since just after the Brexit vote in 2016.
Should a leadership contest be triggered, then the pound could slump by 1 percent to 2 percent, according to Jordan Rochester, an analyst at Nomura.
“The way the pound is currently trading,” with the drop below $1.30 this week, “it would appear the market is partially pricing in a challenge,” said Neil Jones, head of hedge fund sales at Mizuho Bank Ltd.