Signs that arch-Brexiteer Boris Johnson may be a step closer to becoming Britain’s next prime minister sent the pound tumbling to a five-month low versus the euro on Tuesday and towards $1.25 as investors worried about the risks of a disruptive Brexit.
The pound dived to 89.74 pence versus the euro, its lowest level since mid-January, as a second round of voting in the Tory leadership contest began and looked likely to cement frontrunner Johnson’s pole position among rivals.
The results of the vote are due around 1700 GMT. Once the candidates are whittled down to the final two, the mainly pro-Brexit Conservative Party members will cast the deciding votes in July to select a leader to replace Prime Minister Theresa May.
Against the dollar, sterling dropped 0.2% to $1.2507, its weakest since January.
“The Conservative Party leadership race remains the primary focus for UK markets,” said Scotiabank analysts. “A strong showing for BoJo (Boris Johnson) may weigh a little on the pound.”
Johnson has said he will take Britain out of the European Union by Oct. 31 whether or not there is a deal with Brussels to smooth the transition.
The pound has weakened more than 6% against the euro since early May as investors have raised their bearish bets against the British currency on worries that Britain may crash out of the European Union without a deal on Oct. 31.
Sterling staged a small recovery by 1300 GMT as the euro sold off following comments from European Central Bank President Mario Draghi that raised the possibility of an interest rate cut to boost the euro zone economy.
UBS wealth management said it believed fears of a no-deal Brexit at the end of October, the deadline for Britain to leave the EU, were overdone.
“UBS’s base case is a further extension of the October deadline and eventually general elections in the UK, which should keep the exchange rate in a range around 0.87 (87 pence per euro) over 12 months,” its chief investment officer said in a research note to clients.
Short bets against the British currency have been trimmed somewhat recently, but overall sentiment is fragile and recent optimistic talk from the Bank of England has done little to dispel the cloud of gloom hanging over the pound.
While policymakers have said that benchmark interest rates may need to rise sooner than markets expect, traders are in no hurry to shift their expectations, with futures markets pricing in no rate hikes well into late 2020.