Pound rallies before no-confidence vote

The pound is trading over $1.26 as traders bet that Prime Minister Theresa May would survive a no-confidence vote on her leadership.

Ranko Berich, Head of Market Analysis at Monex Europe, commented: “If May’s boisterous reception in the commons and tweets from Tory MPs are to be believed, May is more likely to survive tonight’s vote than not. This appears to be the market’s base case, with sterling rallying slightly this morning towards the 1.26 handle against USD despite the possibility of utter disaster in the event May loses and the UK heads for a no-deal outcome.

“Sterling’s mild upside this morning appears to be driven by optimism that May will cruise through tonight’s vote and emerge strengthened. If she does survive, her situation will be marginally improved as she will be in a stronger position to argue that Parliament’s options are her deal or no deal. As a result, sterling will likely enjoy a mild reprieve to around the $1.27 level until the next lurching crisis pushes it back down.

“Although the prospect of a marginally strengthened May removes some downside risk for sterling, any relief rally will be limited unless tonight’s vote demonstrates a sudden increase in Tory support for May’s deal. As a result, the vote split will be significant for sterling and for markets in general. The breakdown of votes will replace yesterday’s cancelled meaningful vote in Parliament as a barometer for how many Tory MPs May needs to win over to wrangle her deal through parliament in the new year.

“If May wins the vote by a narrow margin, fears of failure or a vote of no confidence in the commons will intensify, although ironically the impact of a general election on sterling is difficult to call as it would introduce a real prospect of reversing Brexit altogether.

“If May loses tonight’s vote, all hell will break loose for sterling as several scenarios that were previously tail risks become more plausible, with the net effect being to substantially increase the likelihood of a catastrophic no deal outcome. With Raab leading the bookies’ odds for a replacement and the EU in no mood to give way, markets will have no choice but to price a no deal as a probable outcome and push back expectations of a March deadline. Our view is that this will take sterling down some 3%, with GBPUSD likely to test 2016’s 30-year lows around the $1.20 level.”