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After initial losses, Sterling recovered ground strongly on Friday as the dollar retreated and risk appetite recovered.
From lows near 1.1060, the Pound to Dollar (GBP/USD) exchange rate rallied strongly to highs above 1.1300.
There was a fresh spike higher ahead of Monday’s Asian open with highs above 1.1400 as former Prime Minister Johnson decided against standing to be the next Conservative Leader.
The Pound to Euro (GBP/EUR) exchange rate also posted higher around 1.1540.
GBP/EUR retreated to 1.1520 with GBP/USD dipping to 1.1320 with markets expecting further volatility.
On Sunday evening former Prime Minister Johnson decided against standing for the Conservative Party leadership.
This puts former Chancellor Sunak in a very strong position and bookmakers consider he has a 95% chance of becoming leader and Prime Minister, although it could still go to a ballot if Mordaunt is able to secure enough support.
Markets will be relieved if there is an easing of uncertainty, but there will be major political and economic challenges.
Neil Mehta, Portfolio Manager at BlueBay, commented; “A political reset would continue to erase the risk-premium embedded in UK assets, particularly if front-runner Rishi Sunak becomes prime minister and implements more orthodox conservative economic policy.”
He was still cautious over the outlook;
“This will likely embolden Gilts and the pound, but the longer-term challenges facing the UK economy on cost of living and inflation will unlikely abate – with a Labour government in the waiting.”
ING added; “Sterling price action seems to assume the advent of a Sunak/Hunt ticket as PM/Chancellor and a focus on trying to restore some of the UK’s lost fiscal credibility.”
ING also remains cautious over the outlook; “After the failed experiment with Trussonomics, the challenge facing the new team will be harder than the one that existed earlier this summer and probably a reason why international investors will not want to chase GBP/USD above the 1.15 level.”
Commerzbank looks at the European dimension; “As British politics under Johnson’s leadership would have threatened minimal consensus with Europe, his return to office would have been GBP negative. However, until it becomes clear who is going to be the next British Prime Minister and what the view of the next government towards Europe is going to be, too much GBP strength is not justified either.”
Credit Agricole expects difficulties in finding party unity; “Over medium- to long-term, we further worry that the deep divisions inside the Tory party could complicate the implementation of any meaningful structural reforms and boost economic growth. As a result, political uncertainty could remain a semi- permanent feature of the GBP fundamental backdrop.”
Goldman Sachs considers that the Bank of England expectations are still too high and adds; “we continue to think that Sterling should fall further in coming weeks.”
It added; “Just how far will partly depend on the Prime Minister, and whether he or she can put together a credible policy framework.”
Unicredt added; “The bleak UK political climate remains a drag for sterling.”
According to Scotiabank GBP/USD faces tough resistance; “Holding above 1.11 on the close will be positive – but, after a couple of failures in the upper 1.14s, the main risk for the pound appears to a gearing towards a retest of last week’s low at 1.0925.”
