Article Highlights

  • Sterling at highest since June 14, shrugs off Davis resignation
  • Traders believe softer Brexit more likely after Friday agreement
  • Big question for markets is risk to May leadership
  • Market expectations for August BoE hike rise to 69 pct
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Sterling rallied on Monday as traders bet the resignation of British Brexit minister David Davis would not endanger the prime minister and instead focused on the government’s newly-announced plan that markets believe makes a “soft Brexit” more likely.

In a blow to Prime Minister Theresa May, Davis resigned overnight because he was not willing to be “a reluctant conscript” to her hard-won Brexit agreement with the cabinet.

Under the plan, Britain and the European Union would keep close trade ties but Davis believed this would hand too much power to the European Union in the exit talks.

Davis, however, said on Monday that he would not encourage a challenge to May’s leadership, fueling sterling’s rally as investors speculated that the exit from the cabinet of a chief opponent to a softer Brexit would make it easier for her to negotiate with Brussels.

The British currency gained as much as half a percent to $1.3363, its strongest best level since June 14, with most of the rise following Davis’s comments that played down the risk to May posed by his departure.

Sterling strengthened 0.3 percent against the euro to 88.17 pence per euro before easing back.

“She’s survived resignations before; she can survive again,” said Nomura strategist Jordan Rochester, adding that the major risk for the pound would be if the Conservative prime minister’s leadership looked untenable.

The Davis resignation has underlined May’s limited ability to impose cabinet discipline around a softer Brexit strategy. However, analysts said May’s success in getting broad agreement for her plan for life after the EU was more important.

UBS Global Wealth Management’s chief economist Paul Donovan said the market reaction was “almost as if investors do not know who Davis is.”

Under the agreement announced by May on Friday, Britain will retain a close trading relationship with the EU, making the sort of arrangement business leaders have called for in recent weeks more likely.

“It’s a softer Brexit and it’s a plan. A plan is better than no plan. The market is extrapolating that the EU will get more concessions out of the UK,” bringing the two sides towards something like a customs union as favored by markets, Nomura’s Rochester said.

May announced Davis’s replacement as Brexit campaigner Dominic Raab.

BOE BOOST

Broad-based dollar weakness also supported the pound’s bounce, while data this week could raise expectations of a Bank of England interest rate rise in August if they suggest growing economic momentum in the second quarter.

“News that Brexiteer David Davis has resigned looks welcome news to those looking for a soft Brexit. The question will be what further backlash (leadership attack) May now faces from the right wing of the (Conservative) party,” said ING analysts in a note.

They predicted that sterling could hit $1.3450 if the EU signals its openness to Britain’s Brexit proposal and if the BoE sticks to a slightly hawkish script. Markets are now pricing in a 68 percent chance of a rate rise in August.

Sterling has climbed 2.3 percent since hitting a 7-1/2 month low in late June, boosted by improving economic sentiment and signs that May had faced down the hard Brexiteers in her cabinet.