Traders paused their heavy selling of the pound on Wednesday but the British currency remained stuck near its weakest since 2017 and analysts are predicting renewed volatility.
Risks of a no-confidence vote in the new Conservative government as soon as it comes back from the summer recess, or an early election are two of the many scenarios investors envision happening as a Oct. 31 deadline to leave the European Union approaches.
Boris Johnson, who took over as prime minister two weeks ago, said he would take Britain out of the EU in three months "do or die" as he formed a new cabinet filled predominantly with Brexiteers.
He said he is looking to negotiate a deal with the bloc, but he also demanded that Brussels show a willingness to change the deal it agreed with his predecessor before negotiations.
If a deal is not found by October, Britain will leave the EU without an agreement in place, Johnson said.
Johnson's insistence that Britain is boosting preparations to leave without a divorce agreement if Brussels refuses to renegotiate has spooked markets, and last week it sent the pound tumbling.
With the clock ticking, there may be no time left to prevent a no-deal exit, analysts say. Most investors have been forced to recalculate their assumptions of a no-deal Brexit.
"There are many key dates ahead for sterling, but the passing of Sept. 5 without a successful motion of no-confidence in the government will in our view be a further important step along the road of a no-deal Brexit on Oct. 31," said Derek Halpenny, head of research at MUFG.
The pound was slightly lower at $1.2151 on Wednesday, not far from the 31-month low of $1.2080 it reached at the beginning of the month.
Against the euro, the pound was also not far from the 23-month low it hit on Tuesday, last trading flat at 92.10 pence .
However, the derivatives market implies that traders foresee further sterling weakness.
Three-month sterling risk reversals, which cover the October deadline, show that investors have been buying more options betting the pound would fall than options betting it would rise.
According to the Commodity Futures Trading Commission data, leveraged funds added more net short sterling positions in the week to July 30, taking the amount of contracts to $6.85 billion, its highest since May 2017.
Andreas Koenig, head of global forex at asset manager Amundi, said he was underweight sterling, but only slightly because the many possible Brexit scenarios leave the door open for sterling moving in either direction. (Reuters)