Pound at two year low but Hunt premiership could improve currency outlook

Brexit uncertainty has kept the UK's economy under pressure, with recent data such as retail sales and purchasing managers’ surveys suggesting a contraction in the second quarter.

Sterling is weak while the greenback is being supported by US-China trade tensions. Reuters

A surprise win for underdog Jeremy Hunt in the contest to become UK prime minister would cause the pound to rally from near a two-year low -- but not for long, according to Bloomberg.

A victory by Mr Hunt, who was only backed by 26 per cent of Conservative Party members in a recent poll, could cause a jump in sterling as he is more likely to avoid the UK crashing out of the European Union without a deal, strategists say. The relief would only be temporary given he is likely to face the same problems as incumbent Theresa May: the challenge to renegotiate a deal that Brussels has refused to reopen and to win support for it in a divided parliament.

“It wouldn’t have a sustained impact in part because the risk of an accidental no-deal Brexit may persist even with Mr Hunt at the helm of the Tory party,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole.

Mr Johnson, the overwhelming favorite to win, has pledged to lead the UK out of the bloc by the October 31 deadline,“do or die,” with or without a deal. The result of the vote on the duo by Conservative members is expected on July 23, in a contest sparked by Mrs May stepping down after failing to get her Brexit deal through parliament.

Both Mrs May and Mr Hunt backed remaining in the bloc in the 2016 referendum, though both have since embraced Brexit. Mr Hunt has said he would pursue a no-deal exit with a “heavy heart” if the EU refuses to renegotiate. He has said he would delay Brexit again if there’s a good chance of improving the deal.

Mr Hunt is “May 2.0,” said Societe Generale strategist Kenneth Broux. He sees the pound rallying as high as $1.27 on a win for the Foreign Secretary before the currency gives back those gains when Parliament returns in September. The pound has slid around 5 per cent in the last three months as the risk of no deal grows and the economic outlook darkens.

“Hunt does not change my view that pound rallies are still a sell until there is clarity around the Oct. 31 deadline,” Mr Broux said.

It’s not just the politics worrying pound traders. The UK economy is headed for a contraction in the second quarter, according to a Bloomberg survey of economists, and a gauge of data performance versus expectations is at its lowest level since 2011.

The UK is likely to continue to underperform “growth wise and politics wise,” according to Jordan Rochester, a currency strategist at Nomura International. Still, there could be some positives of a Hunt win for markets. The new chancellor, and next Bank of England governor to replace Mark Carney after he steps down in January, would likely be “less exciting and more steady” under a Hunt government than under Johnson, he said.

Britain’s economic gloom and a fast-approaching Brexit deadline kept sterling near two-year lows on Wednesday, while diplomatic spats with the US and China highlighted the country’s troubled ties with other trade and political partners.

The past two weeks or so have seen a sharply deteriorating outlook for the British currency, which is set for a record 10-week losing streak versus the euro. Against the dollar, it is at its weakest since April 2017, excepting a “flash crash” in January.

“It looks like sterling is managing to find bad news everywhere,” said Adam Cole, chief currency strategist at RBC Capital Markets in London.

“Sterling is characterised by fat-tail risks in both directions, but at the moment downside risks dominate.”

A raft of dismal data and the risk of crashing out of the European Union without agreeing transitional trade arrangements has forced the Bank of England to change its upbeat assessment of the economy. Its hitherto hawkish stance, at odds with other central banks in the developed world, had been a key source of support for sterling this year.

That was kicked away last week, however, as governor Mark Carney suggested the bank might join peers in cutting interest rates.

Mr Johnson has not ruled out suspending, or “proroguing”, parliament to prevent it blocking a disorderly Brexit.

“The risk of a no-deal Brexit rose when it become clear Johnson might be the next PM, and nothing Johnson has said has diminished that risk,” Mr Cole said.

The Brexit uncertainty has kept the economy under pressure, with recent data such as retail sales and purchasing managers’ surveys suggesting a contraction in the second quarter.

The composite UK PMI has slipped into contraction for the first time since mid-2016, data last week showed, a sign the hitherto buoyant services sector is also slowing.

While Wednesday data showed a faster-than-forecast 0.3 per cent growth in May, that did nothing to counter the gloom.

“Yesterday we saw tremendous concerns and honestly the trigger was a minor retail sales publication. If such a minor thing can trigger such a sharp depreciation it shows that there are several reasons for pound sterling weakness,” said Esther Reichelt, FX Strategist at Commerzbank in Frankfurt.

“A new prime minister coming up, no solution available or apparent for Brexit, and additionally growth concerns and the market increasingly only pricing in Bank of England rate cuts – of course these are all factors weighing on sterling.”