Sterling rebound fizzles but markets think May can hold on
- Markets expect May will survive but risks remain
- GDP data, dollar rally, dents pound recovery
- Economists think soft Brexit now more likely
Sterling recovered some of the losses suffered after two ministers quit over the government's Brexit plans with markets expecting Theresa May to survive as prime minister to start negotiating her blueprint with the European Union.
The pound only briefly remained in positive territory on Tuesday, however, after official gross domestic product data was in line with forecasts and a stronger dollar weighed on the currency.
The resignations of Foreign Secretary Boris Johnson and Brexit minister David Davis shattered May's attempt at presenting a unified cabinet approach for life after Britain leaves the European Union. May had unveiled her hard-fought and long-awaited Brexit blueprint on Friday.
The pound tumbled more than a cent to below $1.32 on Monday amid speculation that May would face a leadership challenge, plunging Britain into deeper political turmoil less than nine months before it is to exit the EU in March 2019.
May's office said on Monday she would fight any challenge to her leadership and at a meeting with her Conservative Party lawmakers she was cheered and applauded by many
Even if May is safe for now, the big question for markets is whether Brussels will go along with her plan as a new round of negotiations begin later this month.
Markets had welcomed May's proposals as they retain close trade ties with the EU.
"On our baseline, both the eurosceptics in the Conservative Party and the EU's Brexit negotiators in Brussels give Ms. May's Chequers proposal the benefit of the doubt - for now," said analysts at Goldman Sachs, referring to the prime minister's Chequers country home where Friday's Brexit plan was agreed.
The analysts, however, said risks to the baseline had risen. Parliamentary arithmetic could frustrate May's ability to win legislative approval for her plan and the EU may demand more concessions from Britain, angering pro-Brexit ministers.
Sterling rose to as high as $1.3301 - roughly where it was on Friday before the resignations - until the weaker data and rallying dollar knocked it back to $1.3234, down 0.2pc on the day.
Against the euro sterling held on to its gains, spurred on by weakness in the common currency. The pound stood 0.3 percent higher at 88.365 pence per euro.
UK five-year credit default swaps, a form of insurance against debt default, stood at 24 basis points according to IHS Markit data, the highest level since May 29 but unchanged since Friday.
The internationally-exposed FTSE 100 share index edged higher. UK government bond yields rose after falling on Monday.
"We are now positioned with a small long position (on sterling), mainly via options, to take advantage of volatility in either direction," said Marilyn Watson, Head of Global Fundamental Bond Product Strategy at BlackRock.
"The range of outcomes and tail risks on both sides are now more extreme, in terms of the potential for a soft Brexit, but on the other hand we also think there's a greater possibility we could have a hard Brexit."
Traders are also preparing for more British economic data that, if better than forecast, may heighten expectations of a Bank of England interest rate rise.
The improvement in data and upbeat comments from BoE Governor Mark Carney has lifted expectations of an August rate hike to more than 70pc from less than 50pc two weeks ago.