Sterling bounces on Brexit hopes, but Tory conference keeps investors wary

LONDON (Reuters) - The pound bounced on Monday, rising above $1.31 after a big selloff the previous session, but investors said upbeat comments from Britain’s Brexit minister about a possible deal with the EU would not support the currency for long.

FILE PHOTO: A shop assistant counts piles of British Pound Sterling banknotes at an Apple store in London, Britain November 18, 2017. REUTERS/Russell Boyce

Sterling tumbled two cents against the dollar on Friday, its biggest daily drop this year, after Prime Minister Theresa May said Brexit talks had reached an impasse.

On Monday, the pound recouped 0.7 percent to reach $1.3167 and gained 0.3 percent against the euro to 89.37 pence as some of the short positions on the pound were unwound.

Brexit minister Dominic Raab said he was confident Britain would eventually clinch a deal with the European Union.

But those comments were unlikely to support the currency for long, analysts said, with May’s leadership under increasing pressure ahead of her Conservatives’ annual conference this week.

“An aggressive stance from the EU... and the subsequent backlash from Theresa May increases the probability that a confrontation builds through the ...conference,” Deutsche Bank currency strategist George Saravelos wrote in a note to clients.

Friday’s selloff was a brutal reminder for investors of the currency’s vulnerability to Brexit headlines.

The pound fell to as low as $1.3053 and month implied volatility - a measure of expected price swings - jumped to its highest since February, in its biggest daily rise since January.

“An imminent agreement in the Brexit negotiations cannot be expected,” said Esther Maria Reichelt, an FX strategist at Commerzbank in Frankfurt.

“Under that assumption, the current levels on the options market still provide good opportunities for hedging against further exchange rate turbulence.”

Britain’s opposition Labour Party will vote this week on whether to keep a second Brexit referendum as an option if Theresa May fails to get her plan for quitting the EU through parliament.

That places further pressure on May though it is unclear what impact the prospect of a second referendum would have on sterling.

“We doubt this option will impact the pound. A lot of dire developments would probably have to take place first before a second referendum happens,” said analysts at MUFG.

Many investors still expect Brussels and London to reach agreement. Both have much to lose if Britain were to crash out of the EU next March without a trade arrangement in place.

But investors have been hastily hedging against more weakness in sterling should the negotiations with the EU collapse.

Reporting by Tom Finn; Editing by John Stonestreet and Hugh Lawson