Pound Sterling / Euro: Scrutiny Falls on Johnson's GATT 24 Plan as Exchange Rate Defends Key 1.1150 Level
Above: Boris Johnson. File image. © The Naked Ape. Accessed Flickr, reproduced under Creative Commons licensing.
- GATT 24 in the spotlight
- Sterling under pressure in midweek trade
- October 31 deadline is a "do or die" says Johnson
Pound Sterling / Euro: Scrutiny Falls on Johnson's GATT 24 Plan as Exchange Rate Defends Key 1.1150 Level
The British Pound is looking to defend the key level of 1.1150 over the course of Wednesday, June 26: if GBP/EUR can close above here then it tells us the 1.1150-1.1250 range that has been growing over the past two weeks is still intact.
At the time of writing the exchange rate is quoted at 1.1167, marginally higher than where it was at the start of the day.
If the exchange rate closes below 1.1150 then it would be fair to say the broader down move, in place since early May, is gaining traction once again. However, if the exchange rate can close above 1.1150 then a sideways-orientated range could be forming and a short-term rebound into the range cannot be ruled out going forward.
Whether Sterling sells off further will ultimately rest on how foreign exchange markets interpret the Brexit policy of the likely next Prime Minister, Boris Johnson. We maintain that Johnson's intentions for Brexit remain the single-most important driver for Sterling over coming days and weeks.
Johnson was interviewed in various media sources on Tuesday, allowing us some further details as to how he intends to deal with Brexit.
We note that Johnson's first plan would be to renegotiate the Brexit deal, and in particular, a phrase that stuck with us was his comment on a 'no deal' Brexit outcome: "it is not where I want us to end up, it's not where I believe for a moment we will end up."
This is significant, and on balance positive for Sterling.
However, the route towards attaining a deal is not clear, and this would explain why markets are somewhat still nervous, we believe.
"Like PM Theresa May, Boris Johnson, her likely successor, is promising Brexit. It's worth betting that won't deliver, either, leaving the Pound treading water at familiar levels," says Jeremy Boulton, FX Analyst with Thomson Reuters. "Volatility is low and looks set to remain so with a great deal of uncertainty restricting traders but the stimulus arising from the uncertainty encouraging risk-taking. Volatility for Sterling is way below the double-digit levels that would be trading if a disorderly UK exit from the European Union looked likely."
For Johnson, much of the emerging Brexit strategy rests with one prominent plan that would see the UK leave the EU on October 31, but keep trading conditions more-or-less unchanged while a trade deal is negotiated.
A provision for such an arrangement could be made under the General Agreement on Tariffs and Trade (GATT) - specifically Article 24 of GATT - allowing the UK and EU to avoid tariffs until such a time a free trade deal is secured.
Critically - and Johnson does acknowledge this - the plan does require both the EU and UK to sign up.
The rub for Johnson's strategy is therefore of course getting the EU to sign up to the plan: EU leaders and officials have consistently said there is only one deal on the table: that agreed with Prime Minister Theresa May.
"In order to benefit from the terms of Article 24, there must be an agreement between two WTO members as to the elimination of duties and other restrictive regulations on substantially all trade," says International Trade Secretary, Liam Fox. "Therefore, Article 24 would not, by itself, allow the UK to maintain tariff-free trade with the EU in the absence of a negotiated agreement."
Fox adds:
"A 'no deal' scenario, by definition, suggests that there would be no mutual agreement between the UK and the EU on any temporary or permanent arrangement. In those circumstances Article 24 cannot be used. The European Union has made it clear on a number of occasions that full tariffs will be applied to the United Kingdom in the event of 'no deal'."
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Johnson has nevertheless said the UK would be leaving the EU "do or die, come what may" on October 31, with or without EU agreement on GATT 24.
In all, there are broad outlines of a plan being communicated by Johnson, but markets are not yet convinced that any of them will fly with the EU.
"Boris Johnson is adamant the UK is leaving and he is very likely to win the leadership contest. We are heading for a showdown – a no-deal Brexit; a general election; or a 2nd referendum. The Pound is set to come under renewed downward pressure over the coming weeks with no deal still very much under-priced," says Derek Halpenny, an analyst with MUFG.
It is however worth noting there has been no responses to Johnson's fledgling plans by any EU leaders or officials; typically we would expect at least one or two rebuffs by now. It is of course too early to read into this silence, but it is interesting nevertheless. We simply don't see how the EU can effectively 'blank' the next Prime Minister and there will surely be some discourse to be had.
Foreign exchange analysts at UK high-street lender Barclays have meanwhile released research that suggests the decline in Sterling is not yet over, and further falls against the Euro and U.S. Dollar are likely.
"We are turning increasingly more bearish on the GBP because Brexit-induced political and business uncertainty is likely to cap any upside for the Pound," says Nikolaos Sgouropoulos, an analyst with Barclays in London.
It is believed the Euro can continue to rise further against the Pound "over the coming quarter as markets re-assess the risks associated with a no-deal Brexit," says Sgouropoulos.
Expectations for both a 'no deal' Brexit and General Election have risen notably since early May after Prime Minister Theresa May's Brexit deal was rejected by the UK parliament and she resigned her position.
Boris Johnson is the firm favourite to replace May, and his firm commitment to leave the EU by October 31 has left markets believing that either a 'no deal' Brexit will be achieved or the Government will be brought down in a vote of no-confidence by a parliament opposed to leaving the EU without a deal.
Johnson has however maintained that he will be working for a new deal as a priority, and in an interview broadcast on Monday night says a 'no deal' is "not where I believe for a moment we will end up".
"While we still envision a deal by year-end, our conviction is generally low," says Sgouropoulos.
Furthermore, Barclays note the domestic economy is slowing, as is the previously resilient UK labour market while a weak global backdrop is unlikely to provide much support to the Pound either.
Barclays see The GBP/EUR exchange rate trading at 1.11 by the end of September, but a recovery to 1.1235 should be seen by the end of the year.
A further recovery to 1.1363 is forecast by the end of March 2020.
Against the U.S. Dollar, Sterling is expected to hold onto current levels.
The GBP/USD exchange rate is forecast to trade at 1.27 by end-September, but a decline to 1.25 is expected by year-end and a move yet lower to 1.23 is predicted by end-March 2019.
"Risks to our GBP forecasts skew to the downside and can materialise either from a realisation of a no-deal Brexit or further delays in the process, with associated increased uncertainty related to an early election or second referendum," says Sgouropoulos.
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