Little Solace in Sight for Pound as U.K. Political Risks Mount

(Bloomberg) -- There is little on the horizon that can help the pound regain its footing as investors brace for subdued U.K. economic data and the risk of a euroskeptic prime minister.

Sterling fell for a third month against the dollar in May and touched its weakest level since January versus the euro on May 31 amid persistent market anxiety about Britain's political upheaval and its implications for exiting the European Union. Morgan Stanley and ING Groep NV both cut their pound forecasts this week ahead of Theresa May's official resignation on June 7, which would accelerate campaigns by Conservative lawmakers to take her place.

U.K. purchasing managers data for manufacturing and services to be released next week are forecast to show a subdued pace of growth.

“The prospects of a new euro-skeptic prime minister are unlikely to bode well for the markets,” said ING strategist Petr Krpata, who predicts the pound will drop about 5% to $1.20 in the coming months. “It should increase the perceived probability of a hard Brexit and this is a clear negative for sterling.”

After last month's European parliamentary elections boosted Nigel Farage's populist Brexit Party, markets are bracing for a harder line, anti-EU prime minister. This has escalated the prospects of a messy divorce, according to analysts who have delayed their calls for Bank of England interest-rate hikes and lowered forecasts for the pound.

“The probability of a smooth and soft Brexit has reduced, in our view, with the Brexit Party winning the largest share of votes in the European elections and the departure of PM May,” said Hans Redeker, global head of currency strategy at Morgan Stanley International. “The next Conservative Party leader is likely to favor a hard Brexit.”

The pound slipped against all of its Group-of-10 peers in May. It weakened 2.6% against the euro to 88.60 pence and 3.2% to $1.2620 last month, as of 4 p.m. Friday in London. Morgan Stanley strategists predict sterling will slip to $1.24 by the end of September and to $1.27 by Dec. 31, compared to previous forecasts of $1.32 and $1.38 respectively.

The year-end pound forecast in Bloomberg's currency survey has fallen to $1.33 from $1.36 as of April 30 as forecasters play catch-up with sterling's descent. Six-month sterling-dollar risk-reversals, a gauge that covers the Oct. 31 formal deadline for the U.K.'s departure, on Friday signaled its most bearish pound sentiment since early April.

Against the euro, Morgan Stanley sees sterling at 91 pence by the end of 2019, weaker than the earlier prediction of 84 pence. ING's Krpata saw sterling weakening to 90 pence as “the upcoming Conservative Party leadership battle weighs on the currency.”

With the BOE hamstrung by Brexit uncertainty, markets will look for clues on policy when Governor Mark Carney and his deputy Dave Ramsden both speak publicly next week. Morgan Stanley has delayed its call for a rate hike from next January until August 2020. ING's Krpata also sees the BOE leaving rates on hold for the rest of this year, removing any policy support for sterling.

To contact the reporter on this story: Anooja Debnath in London at adebnath@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, William Shaw, Anil Varma

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