The pound has recovered from its lowest level in more than two years after Boris Johnson bowed to pressure and resigned as Conservative leader.
On Wednesday, the pound had fallen to its lowest level against the dollar since March 2020, sinking to $1.187 as the City watched political chaos unfold in Westminster with a series of ministers resigning and urging Johnson to quit.
Sterling rose back above the $1.20 mark on Thursday as investors welcomed some respite to the political crisis gripping the UK. Several economists were hopeful that risks of a trade war with the EU over the Northern Ireland protocol had eased.
Normally, a state leader resigning and creating new political uncertainty would cause a sharp selloff in the country’s currency, pointed out Investec economist Philip Shaw.
But Johnson’s departure, after two days of “utter domestic political chaos”, should at least reduce some of the downside risks facing the pound, Shaw predicted.
“In its discussions over the Northern Ireland protocol, Boris Johnson’s government has become increasingly hostile towards the EU in recent months, running the risk of increasing trade frictions with the EU,” he said.
“In addition, as public dissatisfaction with the UK government grew, Scottish independence may have seemed more appealing to Scottish voters.”
Modupe Adegbembo, G7 economist at Axa Investment Managers, agreed sterling had benefited from an easing of longer-term political uncertainty.
“We could also see a tangible shift in the government’s approach to Brexit – with the Northern Ireland protocol bill now likely to face more delays and most candidates likely supporting a more constructive approach – notably excluding Liz Truss,” Adegbembo added.
Gabriele Foà, co-portfolio manager at Algebris Investments, said the change in UK leader was “a long-term positive for UK assets”, with prices of UK government bonds, or gilts, calm despite investors not knowing who will replace Johnson.
“The initial reaction in the pound sterling and UK gilts confirm markets are broadly taking the change well. Near-term, however, volatility is likely to persist, as it is likely we will have no clarity on the new prime minister until October, and inflation and the cost-of-living crisis are set to continue to increase until then,” Foà added.
Johnson’s exit lowered the chance of an additional package of government spending soon, said Silvia Dall’Angelo, senior economist at investment manager Federated Hermes.
“Political uncertainty usually drags on economic performance on its own – it weighs on sentiment, and it typically holds business investment decisions back.
“However, it is a second-order issue compared [with] the extreme economic challenges the country is already facing.”
Sterling also rose against the euro on Thursday, gaining nearly a eurocent to €1.18, its highest since late May.
So far this year the pound has lost about 11% of its value against a generally stronger US dollar, hit by rising worries that Britain could fall into recession.
The pound is still worth nearly 20% less against the dollar than before the 2016 EU referendum. In the run-up to the Brexit vote, sterling traded near $1.50, but plunged to a 31-year low of $1.33 once the result came in, and has never returned to pre-referendum levels.
Sterling also slumped early in the pandemic, hitting $1.15 as the UK went into its first lockdown in March 2020.
Kieran Tompkins, assistant economist at Capital Economics, cautioned that the upheaval at No 10 spells fresh trouble for UK assets.
“We suspect that the latest political turmoil in the UK adds to the reasons to expect a renewed rise in the 10-year gilt yield, weakness in the pound, and continued trouble for the FTSE 100,” he said.
