British markets on Wednesday braced for more political drama as Prime Minister Boris Johnson was rocked by further ministerial resignations and calls for him to go, although traders were reluctant to take new positions given the uncertainty.
Bookmakers have slashed odds on Johnson’s imminent departure – Betfair has a 96% chance of him leaving before end-2022 – and analysts said markets had largely priced in his exit after a series of scandals including accusations that he breached his own COVID-19 lockdown rules weakened his authority.
The pound dropped to more than two-year lows but the moves were largely driven by a broad-based rally in the dollar as investors – worried about rising recession risks – looked for safety.
British stocks gained, bouncing a day after hefty losses. Some analysts attributed the gains to hopes for more public spending under a new finance minister, but the rise in share prices was in line with gains across broader markets.
Johnson’s grip on power was weakened by Rishi Sunak quitting as finance minister and Sajid Javid resigning as health secretary on Tuesday. There was no let up on Wednesday with more senior ministers and junior aides turning on Johnson.
Analysts said markets would struggle for clear direction until they knew whether Johnson could weather the storm, or until they had a better understanding of the priorities of Nadhim Zahawi, the new finance minister.
The rapidly changing broader economic backdrop, including concerns about Britain’s weak economic prospects and the Bank of England hiking interest rates just as the economy slows are overshadowing the political drama unfolding in Westminster.
“For now, financial market reaction has been limited, with markets focused on international developments, including the prospect of recessions in key international economies, tightening global financial conditions and looming energy shortages,” said David Page, head of macro research at AXA Investment Managers.
“However, the longer U.K. political uncertainty persists, the more we would expect it to be apparent in U.K. financial markets.”
By 1415 GMT, sterling was 0.3% lower versus the dollar at $1.1918, off the two-year low of $1.1877. Against the euro, sterling rallied 0.5% to 85.46 pence. The euro has borne the brunt of worries about the economic fallout from a surge in natural gas prices.
Britain’s FTSE 100 was up 1.77% while the more domestically-focused FTSE 250 rose 1.5%.
“Expectations are that the new chancellor will lean toward more fiscal generosity than his predecessor has been recently,” said Paul O’Connor, head of UK-based Multi Asset Team at Janus Henderson.
But O’Connor said the new finance minister faced huge challenges, including collapsing consumer confidence, decades-high inflation and a slowing economy. “The new chancellor is not going to be in a position to substantially alter the course of the U.K. economy,” he added.
A new team under Johnson, if he survives, could unveil populist spending measures in the short term but few are betting on him surviving this for long.
Investors expect little respite in the near term for sterling. Implied volatility on the British pound hit a two-week high as traders expect a rocky road for the currency.
The BoE’s trade-weighted sterling index, which measures the pound against a basket of currencies, fell on Monday to its lowest since January last year.
“We see two key factors driving the markets’ indifference to political risk in the UK. Firstly, markets have now all but written off Johnson as PM going forward,” said Stuart Cole at RBC.
“Secondly, there is no clear frontrunner to replace Johnson, so it is hard to take a view on what his departure would mean for policy.”
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.