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Sterling risks will pass despite recent slump, analysts say

Key Points
  • A sharp slump in the price of sterling early on Monday is unlikely to continue, according to currency experts
  • The pound dropped 0.9 percent Monday morning to $1.3070
Prime Minister Theresa May attends the London Conference on Somalia at Lancaster House on May 11, 2017 in London, England.
Jack Hill - WPA Pool | Getty Images

A sharp slump in the price of sterling early on Monday is unlikely to continue, according to currency experts, who believe that fears over U.K. Prime Minister Theresa May's leadership are exaggerated.

The pound dropped 0.9 percent Monday morning to $1.3070, aided by a report by the U.K.'s Sunday Times newspaper which revealed a group of 40 Conservative members of parliament have agreed to sign a letter of no-confidence in May following months of criticism of her leadership.

The key question, analysts say, is whether this represents political noise or real underlying change. "No major names are calling for (May's) head — it probably will be like the attempt to get rid of her a couple of months ago that was unsuccessful. The risk will probably pass," Kallum Pickering, senior U.K. economist at Berenberg, told CNBC via email.

A no-confidence list in early October following May's speech at the Conservative Party annual conference garnered 35 names. The number required to trigger a vote is 48.

The report underscores persistent fears surrounding May's handling of an onslaught of crises facing her Conservative Party, including a weakened majority, internal divisions over Brexit, multiple sexual harassment allegations and cabinet member departures. Brexit proceedings remain sluggish, and EU demands for greater detail on issues like the U.K.'s financial commitments, the rights of EU workers and the Irish border have yet to be met.

UK, EU in fresh round of Brexit negotiations

Early European trading saw the pound suffer its worst fall since November 2, when it hit $1.3043 following the Bank of England's announcement to raise interest rates for the first time since the financial crisis.

"The market would be wise to keep an eye on the news flow in the days ahead, but I think the risks will pass," Pickering continued. This is because, as he wrote in a recent research note, "We see a good chance that the U.K. agrees in principle to the formula for the divorce bill set out by the EU by the end of the year."

The so-called divorce bill is how much the U.K. could pay to fulfil its remaining obligations to the EU as it leaves the bloc. Any potential agreement would reduce the perceived risk of a no-deal "hard Brexit" scenario, Pickering said, "and would likely have (a) positive effect on business confidence and the sterling exchange rate."

Meanwhile, Simon Derrick, chief currency strategist at BNY Mellon, advised against rushing to conclusions. "The key is not to assume that a leadership challenge must lead to a 'no confidence' vote in Parliament," he said.

And even if so, a change in Conservative Party leadership would not automatically lead to a general election — thanks to country's Fixed Term Parliaments Act, an early election requires two-thirds of MPs voting in favor.

UK government 'has to make up its mind' on Brexit, expert says

"It's arguable this is what GBP (sterling) is also reflecting this morning given it has remained in the ranges established over the past month despite the headlines over the weekend. GBP was also calm during the 2016 leadership race," Derrick noted.

"Sterling is undervalued relative to economic fundamentals," Pickering added. "Expect some progress on Brexit in the coming months that will underpin a recovery in sterling – I see cable at 1.40 by end 2019."

William Anderson Jones, head of U.K. corporate dealing at currency trader RationalFX, maintained markets are wary of the ongoing uncertainty, saying in a note, "Investors are particularly concerned at this latest suggestion of disunity in the government as it comes days after the latest round of Brexit talks showed little progress.

"Analysts will be watching political and economic events closely in the coming weeks to see if the pound is able to firm on any positive data or if it will be weighed down further by political uncertainty."