Market liquidity was thin on the first trading day of the year, but the pound’s decline also reflected worries over Britain’s trade negotiations with the European Union following its expected exit from the bloc at the end of this month.
The UK has until the end of 2020 to strike a trade deal and while the deadline can be extended, Prime Minister Boris Johnson has said he will not ask for an extension, despite warnings it would be hard to agree a deal in just under a year.
The final reading of a British manufacturing purchasing managers’ index contributed to the gloom, showing factory output fell in December at the fastest rate since 2012 as a tepid global economy hurt demand and businesses reduced inventories built up in the event of a no-deal Brexit last year.
“The pound was the second worst performing G10 currency overnight amid thin liquidity as markets grow nervous that the recent rally in the pound was overdone,” said Lee Hardman, currency analyst at MUFG.
“At the moment there is still significant uncertainty about the macroeconomic direction over the next few months and so we expect the pound could be more sensitive to data releases going forward,” Hardman said. If sentiment improves and investment picks up, he said, “this would be positive for the pound.”
Sterling lost 0.7% to hit a low of $1.3157, pulling away from the two-week high of $1.3284 hit on New Year’s eve. Versus the euro it was down half a percent to 84.95 pence .
The pound hit peaks of $1.3516 and 82.8 pence to the euro when Boris Johnson’s Conservative Party won the Dec. 12 election, as the result gave clarity to investors that Britain would finally leave the EU after postponing its exit three times.
But optimism has waned. UK businesses reported a fall in Brexit-related uncertainty last month, according to a Bank of England survey that straddled the election. But 42% of respondents did not expect Brexit uncertainty to be resolved until 2021 at the earliest, up from 34% in November.
Uncertainty over the outcome of UK-EU trade negotiations is reflected in implied volatility gauges in sterling which are far more elevated than for other major currencies.