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A real Labour split won't guarantee a surge in sterling

Labour party leader Jeremy Corbyn gives a speech at the County Hotel on June 4, 2017 in Carlisle, England. C
Jeff J Mitchell | Getty Images

Investors predicting a sterling rally if there's a full-blown split in the U.K.'s opposition party are likely to be sorely mistaken.

The U.K.'s Labour party has leaned increasingly to the left since veteran politician Jeremy Corbyn took the reins in 2015. Many currency experts have warned on his policies, saying they fear a Labour government would be more negative for sterling than any disastrous Brexit outcome.

Seven Labour lawmakers (out of 256) split from the party on Monday citing its direction on Brexit, as well as a failure to address anti-Semitism in its ranks. There is now natural speculation that more could follow, ripping a gaping hole in the U.K.'s second-largest party.

While this might diminish Corbyn's chances of being prime minister, a sterling surge is not guaranteed.

"Perhaps at the margin you could argue it's GBP positive ... But a Labour split would not necessarily mean that a single party has a chance of forming a stable government in the event of a snap election, and that is also a factor GBP bulls need to be wary of," Stephen Gallo, the European head of foreign exchange strategy at BMO Capital Markets, told CNBC via email.

Gallo's hypothetical argument is that a snap election this year — if the Brexit negotiations are indeed prolonged — could also mean a split in the Conservative Party with its own Brexit rebels showing frustration at the current management.

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"Who wins a majority in the (House of) Commons (in this scenario)? Answer: perhaps no one ... There is no easy way out of this, unfortunately — for the GBP or for Britain," he added.

The pound barely acknowledged the seven resignations on Monday, with Simon Derrick, chief currency strategist at BNY Mellon, explaining the "jury is out" on what this means for the long term.

"The most immediate question is whether this makes a second (Brexit) referendum more or less likely. I don't know. It's clear that political commentators are asking the same question," he told CNBC via email.

Peter Chatwell, an interest rate strategist at Mizuho, called the creation of the new party on Monday a "bungled mess." In an emailed statement, he said it gives Brexit a less effective opposition and would be a sterling negative.

With currency traders already dealing with numerous Brexit permutations, a Labour split would only complicate a sterling trade that's looking increasingly difficult to call.

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