Sterling, already trading near its lowest in two years, was little moved on Tuesday after Boris Johnson won the contest to be Britain's new prime minister, as investors worried whether he would lead Britain towards a no-deal Brexit.
The pound gradually recovered from early losses and edged back into positive territory after Johnson won. But the move was minimal and analysts said it reflected a mini relief-rally following weeks of losses as markets priced in his victory.
Attention now turns to how many ministers opposed to Johnson's tough line on Brexit will resign in coming days, the make-up of his cabinet and the tone of initial negotiations between the man who was the face of the 2016 Brexit campaign and Brussels.
Johnson has said Britain will leave the EU on the Oct. 31 deadline even if no transitional arrangements are in place. That has panicked investors who fear a no-deal Brexit will cause significant damage to Britain's economy.
Johnson's belligerent tone has taken sterling 2% lower against the dollar this month, and it has depreciated in 11 weeks out of the past 12.
"It will be a very Brexiteer cabinet and markets are set up for that. We have roughly 100 days until Oct. 31 to sort this out, it seems unlikely," said David Zahn, head of global fixed income at Franklin Templeton.
"What we have seen from the new European (Commission) head is that nothing will be changed, it seems like we are headed towards a no-deal Brexit. If both leaders are so entrenched is there much chance of an extension? This materially increases the no-deal Brexit chances, and sterling is pricing this."
Two junior ministers have already quit over Johnson's plans, and finance minister Philip Hammond and justice minister David Gauke have both said they plan to resign before they are sacked.
The pound traded at $1.2472, down 0.1% on the day. Sterling hit a 27-month low of $1.2382 last week.
Against the euro it was down 0.2% at 89.640 pence .
Rallying British stock markets were little moved by news of Johnson's victory, while British gilt yields rose marginally after the result but remained near three-week lows.
Recent weeks have seen investors sharply cut back on sterling positioning, with short positions growing to a 10-month high in the latest week, Commodity Futures Trading Commission data showed.
"(Sterling) is a 'sell on rallies', 100%. Regardless of how you slice the cake, we will either end up with a no-deal (Brexit) or a messy general election," said Stephen Gallo, head of European FX strategy at BMO Capital Markets.
Sterling has also come under pressure in recent weeks from signs the Bank of England may backtrack on policy-tightening signals.
Former Johnson advisor Gerard Lyons, who according to betmaker Betway is favourite to become the next BoE governor, said in an opinion piece for the Financial Times on Tuesday that the central bank should revisit its 2% inflation target.
Policymaker Michael Saunders, who has talked in recent months about the likely need for higher borrowing costs, was quoted as saying by Bloomberg that Brexit might stop the BoE from raising interest rates. (Reuters)