The pound slumped and gilts rallied after Dominic Raab quit as UK Brexit secretary less than 24 hours after Prime Minister Theresa May said she had won cabinet approval for a deal with the European Union.
Investors in the money markets immediately priced out the prospect of a rate increase by the Bank of England next year after Raab said that he couldn’t “in good conscience support the terms proposed for our deal.” His departure stokes fears that a revolt from within her own party may imperil May’s leadership.
“The resignation of Brexit secretary Raab comes at a difficult time for May and could raise the risk of a vote of no-confidence in the PM,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole SA. “The pound is lower on that but it seems that uncertainty could push it lower still.”
Sterling dropped 1% to $1.2860, the worst performance among the Group-of-10 currencies after gaining as much as 0.7% on Wednesday. It weakened 1.1% to 88.01 pence per euro. The yield on 10-year UK government bonds dropped 10 basis points to 1.41%.
Money markets now see the first BOE rate increase in February 2020, compared with November 2019 at the close of trading on Wednesday. That outlook spurred stocks higher, with the benchmark FTSE Index climbing 0.4%.
Pound option risk-reversals remain bearish against both the dollar and euro, with the hurdle of getting the Brexit plan through Parliament still looming even if May dodges a leadership challenge. Implied volatility on one-month pound-dollar contracts was at 12.96%, near the highest level since January 2017.