Sterling plunged briefly below $1.24 for the first time in 27 months on Tuesday and also hit six-month troughs against the euro as the two candidates to be Britain’s next prime minister vied to outgun each other on taking a harder Brexit stance.
Their positions appear to be leading markets to price a sharply higher risk of Britain leaving the European Union on October 31 without any transition trading agreements in place.
That would potentially force the Bank of England (BoE) to cut interest rates to stave off an economic catastrophe.
The pound suffered its biggest one-day fall since March after Boris Johnson and his rival to be Conservative Party leader, Jeremy Hunt, said late on Monday they would not accept the so-called Northern Irish backstop element of Theresa May’s Brexit deal.
Both are trying to appeal to the majority of the Conservative Party members who want to make a clean break with the EU.
Johnson further stoked no-deal Brexit fears by vowing to send British lawmakers home for up to two weeks in October if her becomes prime minister, though sterling weakness was exacerbated by a bounce in the dollar following strong US retail sales data. A move like that could prevent them stopping a no-deal Brexit.
The contest between Johnson and Hunt “has transformed into an arms race of who is a bigger Brexiteer,” said Vasileios Gkionakis, global head of forex strategy at Lombard Odier.
The backstop, one of Brussels’ principal demands in Brexit negotiations, is designed to prevent the return of a hard border between EU member Ireland and British province Northern Ireland. If implemented, the UK would follow many EU rules until arrangements are made to avert a hard border.
“The market is pricing in a higher probability of a no-deal Brexit and an increase of economic pressure...You have the perfect storm for sterling,” Gkionakis added.
The British currency weakened 0.9 percent on Tuesday to $1.2409, having plunged earlier to $1.2396, the lowest since April 2017 and below the “flash crash” of $1.2409 on Jan. 3.
The new Conservative leader is expected to be announced on July 23. According to Refinitiv data, market participants own more than $800 million in sterling ‘put’ options with a strike of $1.20 expiring July 26, making this the next key level to watch for. A put gives the right to sell an asset at a certain price.
Against the euro, the pound fell 0.5 percent to a low of 90.47 pence, the lowest since Jan. 11.
The weakness extended even after employment data showed average weekly earnings unexpectedly rose 3.4 percent year-on-year in the three-months to May. However, the labour market strength is widely attributed to employers hiring workers whom they can later lay off if needed.
And employment growth slowed to post the weakest increase since the three months to August last year, in a sign that labour markets may soon start feeling the heat.
Money markets are now pricing a roughly 50 percent chance of a BoE rate cut by end-year, having increased their bets after recent comments by governor Mark Carney were viewed as dovish.