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Investors Bet Against Pound as Focus Returns to Brexit

The British pound has plunged to a two-month low after the government announced that Prime Minister Theresa May had managed to hold together her divided party, though the deal she has struck still faces challenges.

May had until this past Monday to reach a divorce deal and get it endorsed by Parliament, a day after lawmakers abandoned an earlier attempt at a vote. She had no option but to secure a deal of some sort; Parliament could have rejected a vote outright, overturned a vote to approve a deal, or granted May another vote.

So far, the former is looking unlikely, with the clock ticking on an already tight schedule for negotiations, and the latter an even longer shot. On Friday, lawmakers are slated to vote on whether to fund the Brexit process for the next three months — though there’s no guarantee that’ll happen. May has been struggling to pass a bill that would enable her to delay Britain’s departure from the European Union, amid a stalemate over immigration and an absence of consent from Parliament.

Since the rejection of May’s initial Brexit deal on March 13, the pound has fallen more than 7% against the U.S. dollar. Stocks in London have tumbled more than 4%, and the FTSE 100 index has slumped nearly 7% this week, the second-worst week since the Brexit referendum of 2016.

In 2017, the British government undertook an unprecedented intervention in currency markets with a “sterling cap” to stem falls. The cap has been removed, with the Bank of England having reduced the level of intervention to a lower threshold.

March 4 was the day the Bank signaled the limit was up. It was also the day when Bloomberg, in conjunction with the Bank of England, published a report outlining the potential costs of a hard Brexit.

The pound slumped 4.2% in the wake of that announcement. Goldman Sachs predicts the pound will fall to $1.10 or lower by the end of this year. A weaker pound makes it cheaper for importers and exporters to produce and sell goods, and investors fear that it will hurt the UK economy. Bloomberg notes that Bank economists now predict “Pound weakness could also lead to more inflation and higher rates, ” though the MPC doesn’t have a mandate to target currency rates.

Among the key negotiations at the heart of the clash between May and Parliament is “no deal”, a view shared by HSBC chief economist John Wraith and shared this week by the Bank of England (BBOC), British finance ministers, and London’s mayor Sadiq Khan.

Britain is committed to leaving the EU on March 29, 2019, but that hasn’t stopped May from heading toward December as the date for this option being ruled out, reportedly because it could backfire. A hard Brexit would see Britain unable to reach an agreement with the EU, and its failure to do so could prevent it from leaving the EU at all.

“A deal has to be reached,” says Threadneedle Street (BBOC), the Bank of England. “An EU exit at the end of March can only be finalized if an orderly withdrawal is agreed. The UK and EU need to be able to reach agreement by October so that a transition period of as long as two years can be agreed.”

A lower pound is welcomed by exporters, and would mean less import of foreign currency that weighs on consumers’ wallets. It would also aid efforts to reduce the UK’s Brexit bill, which the government admitted may be in the tens of billions of pounds, if not more.

The BBOC said the UK should make a contingency plan to protect the economy from a prolonged period of low growth and high inflation, in light of “a range of uncertainties” in the coming months. The lawmakers in Parliament have already indicated that they’re likely to ratify Article 50, which triggers the Brexit negotiations.

Should Parliament decide that the May deal is insufficient, or if May’s deal fails to attract enough support, then Article 50 can be delayed, which would buy the government one more vote before Britain’s departure.

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