"Stay Long" on the Pound-to-Euro Exchange Rate say Natwest

Image © Pound Sterling Live

- Brexit to be delayed by three months

- MPs seen having greater say on Brexit outcome

- Sterling to benefit vs. EUR, CAD, CHF

NatWest Markets - the investment banking division of RBS and NatWest - have told clients they remain of the opinion the UK and EU will avoid a 'no deal' scenario on March 29. The view is one that is supportive of a stronger Pound, but according to the latest forecasts from the investment bank, the Pound-to-Euro exchange rate should peak around mid-year before a bout of strength in the Euro pushes the pair back down again.

But, 'no deal' will be avoided courtesy of a three month extension to the Article 50 process and a delaying of the Brexit date.

"By removing a potentially damaging 'no deal', would be consistent with further Sterling appreciation and probably one 25bp Bank Rate hike by the BoE," says Paul Robson, a FX strategist with Natwest Markets in London who adds risks to Pound exchange rates are "to the topside".

NatWest Markets note "Brexit outcomes appear finely balanced with roughly equal probabilities" on Parliamentary ratification of a deal (55%) and No Brexit (for now) via an Article 50 revocation and / or a 2nd referendum (35%).

"Sterling valuations do not fully reflect such a set of probabilities because of high levels of uncertainty," says Robson.

The thinking at NatWest Markets echoes that at HSBC - we reported yesterday HSBC have raised their forecasts for the British Pound on the basis that a 'no Brexit' scenario must now be considered, and that it must enjoy the same weighting as a 'deal' and 'no deal' Brexit outcome.

UK Prime Minister Theresa May told parliament on Tuesday, February 12 that if no deal has been agreed with the EU before February 26 parliament will once again be given the opportunity to have a say on the way forward. We exepect MPs at this point to table amendments and expect one amendment to give parliament the power to instruct the government to formally request a delay to Brexit from the EU.

For Sterling this would be a positive outcome as it provides an insurance policy against a 'no deal' Brexit in the absence of a deal being voted through by parliament; we have seen Sterling outperform a host of rivals thus far in 2019 as the market bet that a 'no deal' Brexit is becoming increasingly unlikely.

NatWest Markets expect heightened focus on the position of the official opposition Labour party and Jeremy Corbyn’s offer of support for a different ‘deal’ to that negotiated by the government.

"Crucially, such a 'deal' could have parliamentary majority support. May told parliament on Tuesday that she is looking forward to further talks with the Labour leader over coming days, but reiterated that entering a customs union with the EU is not one of Corbyn's demands she can consider. Instead, May's offer on workers rights in a post-Brexit Britain could be an area where the Conservative and Labour parties might find common ground.

However, if coming weeks fail to see further fading of 'no deal' risks Robson says we "would likely see a further bout of profit-taking on long Sterling positions."

"However, there will be other opportunities for parliament to take control, so any weakness may be short-lived. With a no-deal outcome still assessed to be unlikely, we stay long Sterling vs CAD, EUR and CHF," says Robson. To be 'long' on a currency is to engage in trades on a currency that yield gains to the trader if that currency rises, to be 'short' a currency is to engage in trades that yield gains for the trader if that currency falls.

NatWest Markets we do not expect large, accelerated moves prior to Mrs May bringing her withdrawal agreement back to Parliament for a final vote later in the month, or perhaps even in March.

The Euro to Struggle

On the other side of the GBP/EUR coin is of course the Euro, and NatWest Markets say the outlook is a challenging one for the single currency.

"We maintain a structurally bearish EUR view as Europe continues to suffer from exposure to the EM slowdown via multinational earnings, manufacturing and trade. Germany seems to have cherry picked from most of the bearish growth aspects of the world today: trade protectionism sentiment, China deleveraging, Brexit uncertainty, auto industry weakness and European populism," says Robson.

NatWest Markets expect the next move from the European Central Bank (ECB) "to be an ease in policy with forward guidance being adjusted in March and the potential for TLTROs in June".

Political risks in the Eurozone are meanwhile expected to ensure the Euro is not considered a 'safe haven' as are the Yen and Swiss Franc.

"For now, we stay short EUR/NOK and EUR/GBP," says Robson.

Natwest Markets economists are forecasting the Pound-to-Euro exchange rate to trade at 1.18 by mid-year, 1.16 by end of September and 1.14 by December 2019.

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