Sterling fell sharply against the dollar and euro on Monday, hurt by a new bout of political uncertainty that soured the outlook for a currency already reeling from weeks of turmoil over whether Britain will stay in the European Union. The resignation of "Brexit" supporter and Works and Pension Secretary Iain Duncan Smith on Friday over planned welfare cuts proposed in last week's budget highlighted a deepening rift within the ruling Conservative Party just three months before a referendum that will determine Britain's future in the European Union.
The uncertainty drove sterling to 7-year lows in late February and traders said the stark division within the ruling party did not bode well for the pound. The cost of hedging against sharp swings in the pound around the time of the referendum rose, reflecting growing uncertainty. "Politics is going to be more important than economics for the next three months in the UK and so far, both major political parties seem pretty keen on tearing themselves apart from within," said Kit Juckes, currency strategist at Societe Generale.
"The resignation of Iain Duncan Smith will simply add another layer of political risk to sterling's prospects." Sterling was down 0.7 percent at $1.4375, holding above last week's low of $1.4053 struck on Wednesday, when the government's 2016 budget trimmed growth and inflation forecasts. The euro was 0.6 percent stronger at 78.31 pence. Smith's criticisms of "unfair" cuts in welfare - unusual in recent history on the British right - also threatened some of the commitments in last week's budget.
"Sterling does not normally react strongly to UK politics so this is probably due to Brexit," said Richard Benson, head of portfolio investment at currency managers Millennium Global. "The referendum is just making people focus on issues like this a lot more. It is down in response this morning." A growing number of banks have warned of the risks of a crisis that could see sterling slide by up to 20 percent if Britain votes on June 23 to leave the EU.
Investors worry that leaving would hit growth and threaten the huge foreign investment flows Britain needs to fund its current account deficit, one of the biggest in the developed world at about 4 percent of national output. Research commissioned by the Confederation of British Industry (CBI) employers' group showed a vote to leave could cost the economy 100 billion pounds ($145 billion) and 950,000 jobs by 2020. And in more bad news for the economy, a monthly survey from the CBI showed manufacturing output volumes fell to -15 in the three months to March from 0 in February, registering its biggest decline since 2009.
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