Politics proves toxic for the pound once again

The pound’s sensitivity to Brexit-inspired political discord has flared up once again. On Tuesday GBP is dipping on the back of fears that Theresa May’s government could face defeat in the Commons if Labour sides with pro-European MPs and calls for the UK to remain in the Customs Union if there is no trade deal with the EU by March next year.

GBP/USD has dropped more than 100 pips and is the worst performer in the G10 FX space today, as the market worries about this latest development. If Theresa May does lose this vote then it seriously weakens her position as Prime Minister. We all know that the hard core Brexiteers want her removed, but now the Remain MPs also seem to be turning on her, which increases the political uncertainty and makes the pound a less attractive option for FX traders.

For the pound, it can be better the devil you know. Theresa May is not the perfect leader, but if she loses the Premiership then who will take her place? A leadership challenge could lead to all-out civil war in the Tory Party and potentially open the way for a Socialist Labour government to come into power?

Added to this, can the Bank of England really hike interest rates if we are in the middle of a political storm? Thus, what happens in the corridors of Westminster could have a direct impact on how Mark Carney and co. at the Bank of England cast their votes at the MPC next month.

Even the head of the Federal Reserve dealt another blow to the pound today, when he called for further rate hikes in the US due to continuing economic strength, making the pound even less attractive.

In the short term the pound’s fortunes are directly linked to Theresa May’s ability to retain power. If she loses this vote then we will see the unravelling of power and likely disintegration in the Brexit negotiations could cause a sharp decline in the pound, potentially back to the 1.20 lows from 2016.

If Theresa May is defeated this evening then we could see volatility spike and further broad-based GBP weakness for the foreseeable future.

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