Pound drops as UK election speculation mounts before Brexit showdown

Sterling weakened on Monday as British media reported that Boris Johnson was preparing to call an election on the eve of a clash between the government and lawmakers opposed to the prime minister's Brexit plans. British media reported that Johnson had called an emergency cabinet meeting for later on Monday, fuelling expectations he would call a vote as he seeks to take his opponents head-on.

Parliament returns on Tuesday and opposition lawmakers are expected to propose legislation to force the government to postpone Brexit beyond the Oct. 31 deadline, which Johnson has vowed to stop happening. Sterling traders are preparing for the battle for Brexit to enter the endgame this week when opposition lawmakers, and possible ruling party rebels, seek to either change the law or the government, in their drive to block what they say would be an economically damaging no-deal Brexit.

Johnson has threatened to expel any rebel lawmakers from his Conservative Party if they try and vote to prevent a no-deal exit from the European Union. Sterling dropped more than 0.8% to as low as $1.2067 - a two-week low - as talk of an imminent election mounted. Against the euro, it declined as much as 0.6% to 90.90 pence.

"The Prime Minister is willing to resist all attempts to prevent a no-deal Brexit and call an election. The House (of Commons) will try and stop him. GBP shorts are big, but a bit smaller than they were. A no-deal Brexit is partly, but not wholly priced in," said Kit Juckes, currency strategist at Societe Generale. According to the latest positioning data, speculators cut their short positions against the pound but - at $6.8 billion - the size of the bet against sterling remains near its biggest since 2017.

Traders are expecting much more volatility in sterling in the coming months, with implied volatility gauges at or near their 2019 highs. Last week, Johnson's government announced parliament would be suspended for around a month in what critics called an attempt to squeeze the time lawmakers had left to try and stop a no-deal Brexit.

"The pound will initially attempt to add to its recent gains if opposition MPs are successful in passing legislation in the week ahead. However, those gains could prove short-lived as it remains unclear how the government will respond to the request from parliament," MUFG analysts said in a note. A widely-watched survey on Monday showed that British manufacturing contracted last month at the fastest rate in seven years, adding to worries about a significant downturn in the UK economy.

The August Purchasing Managers Index for Britain's manufacturing sector came in at 47.4, against a forecast of 48.4 in a Reuters poll of economists. An already weak pound was little moved as Brexit dominated trading. 

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