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Analysts at Nomura explained that Theresa May appears to have gone fully softBrexit (as far as her red lines allow) while the Brexiteers are finally pushing back.  

Key Quotes:

“Consequently, it would seem that either Theresa May faces down this challenge in the coming days and we are on a path to a soft Brexit (still a bumpy path admittedly) or she ends up losing the leadership and the future Brexit policy becomes much less certain.”

“Within that uncertainty, however, we believe there is a clear risk that it would be towards a harder Brexit policy if May is not in charge.”

What does this mean for the August MPC meeting?  

“Political volatility on its own is unlikely to derail the MPC, we would argue. This would set a concerning precedent, and it is unclear why the MPC should focus on it. However, with the market having been over 80% priced for an August hike, one can see why there will be some nerves in coming days if the political volatility worsens and some profit-taking setting in, leading to a fall in the implied probability as shown in the market price. The BoE’s political uncertainty measure is likely to rise but not to extreme levels like we saw in the EU referendum campaign period to warrant another box in the Inflation report.”

What does this mean for Brexit negotiations?  

“The October summit still remains the event risk to bear in mind, in our opinion, but in the short term we think the market focus will be on the domestic politics. What is unlikely to help will be any sign of the EU finding the Chequers agreement unworkable or more “having cake and eating it” rhetoric. It would further add to the pressure on Theresa May in dealing with rebel MPs.”

What does this mean for GBP?  

“We were short GBP via GBP/CAD until this morning.

Where the market had largely ignored the resignation from David Davis and was trading on the back of the softer Brexit Chequers agreement.  

Long GBP/USD given the weaker USD picture had started to gain momentum as a consensus short-term trade.  

We took the short GBP/CAD trade-off given the above but also the underperformance of CAD into this week’s BoC meeting where the risks have turned towards a more dovish outcome.  

Therefore we have missed this move lower today even though we expected the politics to provide a drag thanks to the short-term fluctuations of market sentiment. Given the uncertainty as to how the politics above plays out we have instead been advising short term 2w GBP/USD straddles as attractive positions to hold. Already it has move form 1.19% to 1.27% on the offer and is less attractive.  

But still, it is easy to see how this could escalate and hedging for a substantial move in GBP, either way, is worth paying for.”