Brexit uncertainty continued to undermine sterling, with a 0.3% decline against the US dollar taking its losses over the past three weeks to 3.8%. That followed indications that Prime Minister Theresa May could be forced to abandon a fourth attempt to win approval for her withdrawal agreement, which she had aimed to put to lawmakers in early June. Her revised plan – which included potential votes on a customs union and second referendum – appears not to have convinced many pro-EU moderates and has strengthened opposition among pro-Brexit members of her governing Conservative Party. This has provoked talk that her tenure could be entering its final days.
But the departure of the prime minister could do little to break the UK's political deadlock, and the range of potential outcomes remains wide.
- A no-deal Brexit: The Conservative Party appears to be leaning towards a pro-Brexit replacement for May, with former foreign secretary Boris Johnson currently the leading candidate. The temptation to support a leader who has expressed a willingness to consider a no-deal Brexit could be strengthened by the strong public support for Nigel Farage's new Brexit party, which is currently polling 37% versus 7% for the Conservatives ahead of this week's European Parliament elections. Investors should not be complacent about the threat of a no-deal exit, which we believe would take the pound as low as USD1.15 and 0.97 versus the euro.
- A further Brexit delay: Despite mounting public impatience over the process, many top officials and lawmakers remain fearful of the economic damage from a no-deal exit. The UK Chancellor Philip Hammond spoke to the CBI business lobby about the dangers of this course. This resistance could prompt even a pro-Brexit prime minister to ask EU member states for a further delay to the UK's departure, currently scheduled for 31 October. EU leaders may insist the UK take steps to resolve the political deadlock, which might be broken either through a general election or second referendum on EU membership. Lingering uncertainty would likely cause firms to delay investment, and keep sterling under downward pressure.
- Continued EU membership: UK voters remain deeply divided on Brexit. However, that latest YouGov poll has a 44% vote for continued EU membership in the event of a second referendum, versus 40% to leave. A UK decision to remain an EU member would likely cause a swift rebound in sterling, which we believe is undervalued relative to its purchasing power parity level of around USD1.58.
So, given the difficulty of predicting the outcome we do not recommend strong directional trades on sterling. Although the large-cap FTSE 100 index has benefited from the recent weakness of sterling, we believe the risk-return outlook for UK stocks has become less favorable.
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