Sterling headed on Monday for its biggest one-day fall against the dollar since November 2 as new concerns over Prime Minister Theresa May's ability to advance her plans for Brexit encouraged traders to take profits after a recent surge The pound is up about 4 percent so far this year, as investors expect Britain and the European Union to agree a transition deal soon for the UK's exit from the bloc. But analysts said investors seized on negative headlines on Monday to cut their long positions on the British currency.
The House of Lords Constitution Committee said on Monday that May's legislation to end Britain's EU membership had "fundamental flaws". That followed reports at the end of last week that May was facing another leadership challenge. Britain is due to exit the EU on March 29, 2019, but there are deep divisions inside the government and within May's Conservative party about what sort of relationship should replace 46 years of membership.
Until now, however, those divisions have not appeared to rattle investors, with the currency surging against both the dollar and on a trade-weighted basis since the end of last year. Data on Friday showed speculators added to their bets on the pound strengthening further in the most recent week, with net-long positions at their highest since mid-2014. On Monday, however, sterling skidded 0.8 percent to as weak as $1.4030, hitting five-day lows after Theresa May's spokesman said there was some distance between the EU and Britain on more than one transitional deal issue.
The pound still remains on track for its strongest month against the dollar since July 2010. Against the euro, sterling was 0.2 percent weaker at 87.95 pence. "There's been a little bit of profit-taking after the strong movements we have seen recently. Sterling positions are starting to become stretched," said Martin Arnold, FX strategist at ETF Securities. Having reached its highest level since late June 2016 last week, sterling's trade-weighted index slipped to a six-day low.
One-month sterling risk reversals, which indicate how investors are positioned towards the currency during that period, slipped to their lowest in 12 days, having touched their highest since 2012 last week. Many investors remain upbeat about the pound. Data last week showed Britain's economy unexpectedly picked up speed in the last three months of 2017, reinforcing the view that the hit from the Brexit vote in June 2016 was not as bad as some had anticipated.
"Sterling embodies a range of potential outcomes for Brexit. That includes the risk of a hard Brexit," wrote Berenberg UK economist Kallum Pickering in a note to clients. "If the UK avoids this risk sterling is probably undervalued on real trade-weighted basis by between 5 percent and 10 percent."
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