Brexit "Game of Chicken" to Keep Pound Sterling Nerves Elevated, Consolidation vs. Euro and Dollar

Likely into Thursday's Next Potential Brexit Flare-up

- Raab in Brussels again on Thursday

- Options markets pricing in further GBP downside

- ING downgrade third-quarter Sterling forecasts

Todays rates at Euro Fx;

Euro = 0.870

Stg = 1.10

For large transactions call us on 02871374213

The British Pound is seen consolidating thanks to fading Brexit-related headlines and the impending UK parliamentary summer recess might allow sterling some further breathing room.

We are left with the sense that the last pulse of Sterling selling might have ended. Yet, nerves remain elevated and risks are still biased to the downside we are told.

While there is a likely reduction in Brexit headlines it must be noted that chief Brexit negotiators Dominic Raab and Michel Barnier meet again on Thursday as the pair continue to make haste towards securing a solution on the Irish border.

For now, Sterling is underpinned, though little more. Even with a relatively politics-free week ahead, Brexit Secretary Dominic Raab will meet EU Chief Negotiator Barnier on Thursday. The former has already proven willing to be far more transactional in stance to Brussels than his predecessor. This is anathema for nervy sterling markets," says Ken Odeluga, a financial markets analyst with City Index in London.

Raab has been invited back to Brussels by Barnier to thrash out a solution to the Irish border; this would be most welcome for Sterling markets as it remains a key sticking point and source of angst for the currency.

Last week Barnier "made clear" to Dominic Raab that Europe are "not asking for a border between Northern Ireland and the rest of the UK. What we need is checks on goods because the UK wants to leave the Single Market, the Customs Union and our common commercial policy."

This was certainly a subtle shift in tone, something markets picked up on and rewarded Sterling with some gains.

"We are open to any solutions as long as they are workable and can be transformed into a legally operative text in time for the Withdrawal Agreement," added Barnier.

This suggests to us that the EU acknowledges there is a solution that can be reached that satisfies both sides; this is the compromise markets are yearning for.

"Comments from EU negotiator Michel Barnier on Friday appear quite constructive on UK PM May’s Chequers Brexit proposal when he says he sees a Brexit deal in October/ November and the EU may be able to improve or amend its version of the Irish border backstop or consider alternatives," reads an analysis of the matter from Citi.

The Pound-to-Euro exchange rate recovered back to above 1.12 on the apparent constructive tone offered by Barnier; the exchange rate had been as low as 1.1167. The Pound-to-Dollar exchange rate meanwhile popped back above 1.31 having been as low as 1.2957.

Market Nerves Building as Investors Buy Protection

There is still however certainly a sense that the stakes are being raised as the prospect of a 'no deal' Brexit is raised as a possible outcome by both sides of the negotiating table.

A 'no deal' Brexit is widely seen as being the worst possible outcome for the British Pound by foreign exchange analysts who point to the substantial uncertainties and trade disadvantages this poses to the UK, in the short-term at least.

The EU has warned member states to increase their readiness for a 'no deal' outcome, while new UK Brexit secretary Raab has said the UK could refuse to pay its Brexit bill if no deal is secured.

On such an outcome Sterling is expected to go notably lower; for now though most analysts do not hold this to be a likely outcome.

"The UK and EU appear to be fast descending into a game of chicken over Brexit. PM May has little room to shift more towards the EU's position, but the European Commission remains adamant about not permitting the UK to “cherry-pick”. This game of chicken should raise market nervousness about the Pound," says Alvin Tan at Société Générale.

Tan however suggests implied volatility in Sterling crosses are not particularly elevated - i.e. markets are not buying hedges to guard against sharp rises or sharp falls in the near-future.

Yet, Richard Pace at Thomson Reuters does note "the uncertainty surrounding Brexit has been fuelling demand for cable options in recent sessions, with a notable increase in premiums for GBP put (downside) protection."

"FX options investors are now pricing-in greater downside risks for GBP after several cabinet members resigned over Brexit negotiations. Given political Brexit turmoil, GBP skew has moved for puts. EUR/GBP skew is rising and leading spot on the way up. This is a GBP bearish signal, in our view," adds Vadim Iaralov, a quantitative strategist at Bank of America Merrill Lynch.

This tells us that while markets are not yet panicking, there is certainly a move by the more cautious element of the field to start buying protection against a 'no deal' Brexit.

And with Sterling balancing on a number of technical support levels any further deterioration in sentiment could well lead to a swift move back to 2018 lows in GBP/EUR at 1.1152. However, analysts at ING Bank have suggested the bottom for the exchange rate in the third-quarter 2018 actually lies at 1.0860.

The GBP/USD is meanwhile eyeing a break of the psychologically important level of 1.30, a break of this could invite a move to a trough of 1.27-1.28 suggest ING who have downgraded their forecasts for Sterling for the third quarter of 2018 in expectation for further political challenges to beset the Pound.

This could therefore well be the calm in the eye of the storm.

42 views0 comments