Sterling has dropped after Boris Johnson signalled that he will seek to pass legislation that would create a ‘cliff-edge’ Brexit if a deal is not agreed with the EU by the end of 2020.
The currency slid 1.1 per cent early in the London trading day to $1.318, down more than three cents from the high touched last week after an exit poll projected Mr Johnson’s election victory.
The pound also pulled back against the euro, with currency down by roughly the same margin to €1.1866. London’s benchmark FTSE 100 started the day with a 0.2 per cent slip after a blockbuster gain over the previous two trading days.
Analysts had warned that even as Mr Johnson’s sweeping election win would help to alleviate political uncertainty, risks over Brexit and domestic politics still lingered.
Less than a week after election day, those concerns have come to fruition. Mr Johnson’s government has signalled that it will attempt to ram legislation through parliament this week that would leave the prime minister obliged to make a trade deal within months or take Britain out of the EU on World Trade Organization terms.
“This gave the pound a bit of a fright overnight but fits with our assertion that for markets Brexit will not ‘be done’ even if the UK legally leaves the EU in January 2020 as precisely the question around the follow-on agreement and the length of the transition period is unclear,” said Peter Schaffrik, macro strategist at RBC.
The decision may quash the hopes of some executives, investors and EU diplomats who had expected Mr Johnson to use his decisive parliamentary majority to push for a business-friendly Brexit deal that would marginalise hardline Eurosceptics.
But the new plans suggest Mr Johnson will seek to rapidly forge a Canada-style free trade agreement that would focus on goods trade and not services. It would also set a tight deadline for complex talks — creating yet another point in the next 12 months in which the UK could crash out of the EU with no deal in place.
Investors are also beginning to take a closer look at UK economic fundamentals with the election now out of the way, according to Thu Lan Nguyen, currencies analyst at Commerzbank. She said the release on Monday of a gloomy survey on the factory sector “did not constitute a good start in this respect.”
“What would be particularly important would be to find out to what extent the recent weakness of the British economy was due to the Brexit uncertainty, to the trade conflict or even structural factors,” she said.
“If the real economic weakness was to be deeper and therefore longer term this would constitute an ideal breeding ground for rate cut speculation which might weaken sterling at least temporarily.”
UniCredit analysts said currencies traders would likely look beyond the labour market data, due to be released at 9.30am London time on Tuesday, and instead leave their focus squarely on the Bank of England decision on Thursday. The bank is broadly expected to keep rates on hold but money markets are currently pricing in a slight bias toward a rate cut by the end of next year, according to Bloomberg data.