The new U.K. government’s tough line on Brexit negotiations is pummeling the pound, reflecting increased investor fears the country could crash out of the European Union without an exit agreement.
Concerns about economic disruption have grown since Boris Johnson became prime minister last week. A top official overseeing no-deal preparations jarred investors over the weekend with a statement saying the British government is “operating on the assumption” of a no-deal Brexit.
Two days of heavy selling have raised fears that sterling is heading toward its lowest level against the dollar in more than 34 years. The currency fell to as low as $1.2091 on Tuesday morning, according to FactSet data, before regaining some ground later in the day.
The pound is still above its lowest point since the Brexit vote, which was at $1.2065 in mid-January 2017. Should it breach that level, the pound would be at its cheapest against the dollar since early 1985, when it almost reached parity, except for a minutes-long “flash crash” in October 2016.
The pound is falling as investors and companies adjust their expectations of Britain’s role in global trade and markets.
Though investors had priced in Mr. Johnson’s election as prime minister, most thought his rhetoric and willingness to leave without preparations in place would soften once he assumed residence at 10 Downing Street. Mr. Johnson has shown no indication of wanting to push back the U.K.’s leave.
“People had thought that Boris Johnson may soften his stance once he was in power, but now the market is realizing that a no-deal Brexit is a very real possibility,” said Seema Shah, chief strategist at Principal Global Investors in London.
Mr. Johnson won the Conservative vote to become party leader and then succeeded Theresa May as prime minister last week. He has since named a leadership team packed with Brexiteers, politicians determined to get out of the EU by the next deadline of Oct. 31 by whatever means necessary.
Investors and traders were still assuming that something would turn up to stop such a potentially chaotic outcome and weren’t yet pricing in no-deal as the main scenario, Ms. Shah said. The pound could fall to $1.18 as Oct. 31 approaches, she said.
While the pound has tracked Brexit concerns, U.K. stocks have remained largely impervious because many of the largest companies trading in London are international businesses whose fortunes aren’t linked to the British economy. The FTSE 100 index wavered between gains and losses on Tuesday, after advancing for two straight days. The equity gauge and the pound have moved in opposite directions 71% of the time over the past 30 days, and the FTSE 100 is up about 22% since the Brexit referendum in June 2016.
Meanwhile, investors concerned about the health of the U.K. economy have actually sought safety in U.K. government debt, known as gilts. The yield on 10-year U.K. government bonds declined 1.3 basis points Tuesday to 0.641%, according to Tradeweb. That is the lowest since August 2016.
Analysts are now placing the probability of a no-deal Brexit between 35% and 45%, up from 20% to 30% at the start of July.
It is hard to know if the pound will stay at its current levels given that its fluctuations have been attributable to politics and not economic data, analysts said.
If the currency does remain at the present level, that could push inflation higher next year by about 1% for consumers, said Samuel Tombs, chief U.K. economist at research consulting firm Pantheon Macroeconomics. That could ultimately hurt households, giving them less money to spend outside of basic necessities and curtailing purchasing power for services.
“I don’t think it’s a price worth paying for an unpopular no-deal Brexit,” Mr. Tombs said. “It will hurt households in a very real way.”
The pound is likely to be particularly volatile now because many foreign exchange contracts run for three months, according to Ms. Shah. Speculators, investors and businesses are trying to predict where the pound will be around the deadline for the U.K.’s departure.
“A lot of U.K. businesses realize that a no-deal Brexit doesn’t mean certainty; in fact it’s the definition of uncertainty,” Ms. Shah said.
—Pat Minczeski and Anna Isaac contributed to this article.
Write to Paul J. Davies at email@example.com
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