LONDON (Reuters Breakingviews) - The departure of two senior government ministers in less than 24 hours will either make or break Prime Minister Theresa May and her Brexit negotiations. It certainly makes the pound a more binary bet for investors.
News that Boris Johnson had resigned as foreign minister drove sterling below $1.32 on Monday afternoon, down more than a cent from the day’s highs. Curiously, those peaks had been set after David Davis, the Brexit secretary, quit late on Sunday. Both men stepped down because they disagreed with May’s vision of maintaining close trading ties with the European Union after it leaves the bloc.
Traders viewed Davis’ exit relatively positively because they thought it would give the prime minister a freer hand to negotiate a less economically damaging withdrawal from the EU. That could still be the case. But the departure of Johnson, a more influential figure in the pro-Brexit camp, could embolden lawmakers in the ruling Conservative Party to challenge May’s approach, and possibly her leadership.
That would be a double whammy for the pound. More internal wrangling over Britain’s negotiating stance - or a leadership contest - would waste what little time the government has left to strike a deal with the EU, and raise the risks of a chaotic exit.
What is bad for the UK economy tends to be bad for its currency. But growth may suffer even before the departure date. With less than nine months left before Britain is scheduled to leave the EU, uncertainty is already weighing on business confidence and investment intentions. The political infighting could make it less likely that the Bank of England will tighten monetary policy at its August policy meeting, removing another source of support for the British currency.
The increasingly binary outlook for sterling is only gradually filtering through to the currency options market. Implied volatility, which reflects how much the pound is expected to swing around, rose for one-month euro-sterling options but is still only at its highest levels since mid-June. With more political drama in the offing, the insurance that these derivatives offer is likely to grow more attractive.
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