Sterling languished just off four-month lows, with the outcome of the European election in the UK seen possibly emboldening proponents of a no-deal Brexit as the battle to succeed Prime Minister Theresa May got under way.
The prospect of a no-deal Brexit, which most economists say would severely damage the British economy, re-emerged as a key risk for sterling after Ms May said last week she would step down as leader of the Conservative Party on June 7.
The pound has now fallen for three consecutive weeks versus the dollar and euro. It has lost 3% this month as Ms May failed in her effort to find a Brexit compromise with the opposition Labour Party.
With the Brexit Party handing the ruling Conservatives a drubbing in last week’s European elections in the UK, many Conservative candidates vying for Ms May’s job are under pressure to deliver a more decisive break with the EU when Britain is scheduled to leave on October 31.
While foreign minister Jeremy Hunt said a no-deal Brexit would amount to “political suicide”, other candidates, including front-runner Boris Johnson, have signalled they are prepared for that if Brussels does not reopen negotiations over Ms May’s withdrawal agreement.
However, sterling’s downside was limited by the fact that parties opposing Brexit also made sharp gains in the vote.
The British currency slipped 0.13% to $1.2657, having traded as low as $1.2605 last week. It was down 0.2% versus the euro at 88.40 pence to stand just off four-month lows.
“For the Brexit Party to get so many votes is a sign to politicians that people are not as afraid of the no-deal scenario as most members of parliament. So the no-deal risk has increased a bit,” said Morten Lund, FX strategist at Nordea.
But no-deal Brexit probabilities remain around 15% to 20%, according to Mr Lund, who expects MPs to call a no-confidence vote against any prime minister who chooses that route.
“It’s more or less priced in that Boris Johnson will become prime minister, so with the pricing now I don’t see that much downside. I see sterling trading around these levels but with a downward bias,” he said.
Many analysts noted, however, that the election had also rewarded the Liberal Democrat and Green parties, which have steadfastly opposed Brexit and want another referendum which could reverse the June 2016 vote to leave the EU.