Pound Runs Into Resurgent Political Risks as BOE Bets Fade

(Bloomberg) -- Just when it looked like things couldn't get any worse for the pound, political risks are back on the market's radar.

Sterling is vulnerable to Thursday's local elections in England, the resurgence of Brexit uncertainties and the resignation of one of Prime Minister Theresa May's key pro-European allies in government, according to strategists. The currency made a feeble recovery Wednesday after five days of losses, as disappointing economic data has undermined the prospect of the Bank of England raising interest rates next week.

Political developments “could at any moment blow up to have quite a huge impact because for the last year or so, we've never been that far away from another crisis for the Conservative government,” said Jane Foley, head of currency strategy at Rabobank. “If it looked as if the May government was going through another heightened crisis, the pound would sell off,” while any sign of the U.K. maintaining a close trading relationship with the European Union could support the pound, she said.

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While the local elections don't tend to have a market impact on the scale of a national vote, they will provide investors with a reading on how stable the government is and whether the opposition Labour Party is gaining ground. A poor performance by May's Conservative Party could weigh on the pound, according to Jeremy Stretch, head of Group-of-10 currency strategy at Canadian Imperial Bank of Commerce.

Brexit Risk

Brexit uncertainty is coming back to haunt the market, with the next round of talks beginning Wednesday. With the two sides yet to reach an agreement on the Irish border, European Union chief negotiator Michel Barnier has raised the possibility of a no-deal Brexit at least twice in the past week.

The pound gained 0.3 percent to $1.3652, after falling below $1.36 Tuesday for the first time since Jan. 12. It has slumped around 5 percent from a peak of $1.4377 reached on April 17, which was the highest level since the Brexit referendum in June 2016. The currency could remain under pressure from political concerns unless a services report due Thursday beats expectations, according to CIBC's Stretch.

“It's possible sterling had been trading with a little too much complacency on the Brexit process, meaning there is scope for the market to be surprised,” Rabobank's Foley said. “Sterling has reacted very well to the agreements so far, yet the whole Northern Ireland issue is a gaping hole.”

To contact the reporter on this story: Charlotte Ryan in London at cryan147@bloomberg.net.

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

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