Pound-Euro Week Ahead Forecast: Brexit Saga Finale Opens in Standoff, Threatens Volatility

- GBP/EUR enters week at 1.10 to face immediate Brexit test.
- Downing Street could push for 'no deal' as soon as Monday.
- Deadlock may incite pre-emptive GBP/EUR losses this week.
- 'No deal' risks fall near parity; deal offers only limited upside.

© European Union, 2018 / Source: EC - Audiovisual Service / Photo: Lukasz Kobus

• GBP/EUR spot rate at time of writing: 1.1085
• Bank transfer rate (indicative guide): 1.0797-1.0875
• FX specialist providers (indicative guide): 1.0919-1.1007
• More information on FX specialist rates here

The Pound-to-Euro exchange rate was already troubled by an absence of progress in the Brexit negotiations last week but risks coming apart at the seams over the coming days following weekend reports suggesting a 'no deal' exit could become the government's objective as soon as Monday. 

Pound Sterling faces at least another short-term setback as the Brexit Saga finale opens with a standoff between London and Brussels.

Prime Minister Boris Johnson is reportedly set to address the nation on Monday evening if during business hours negotiators are unable to find a solution to an ongoing deadlock.

The Times reported at the weekend that should Downing Street come to the view that a 'no deal' exit is now necessary, he will have the support of his cabinet including from eight ministers who were opposed to any EU exit.

"We expect a no deal, but no tariffs scenario (effectively a last-minute extension of the transition period) with a framework paper for further negotiations," says Andreas Steno Larsen, chief FX strategist at Nordea Markets.

Barring the path ahead in the talks is still a disagreement resulting from Europe's pursuit of continued influence and control in the British policymaking process, and access to British fishing waters. 

Differences over the so-called level playing field and European access to UK waters remained too large to bridge following a conversation between Johnson and European Commission chief Ursula Von Der Leyen on Saturday. 

Now it is left to the leaders. This really is Boris Johnson’s moment of truth. https://t.co/0CZz4Hm4Zp

— Nigel Farage (@Nigel_Farage) December 4, 2020

Above: Pound-to-Euro rate shown at 4-hour intervals alongside GBP/USD (black line, left axis).

"The EU can agree to accept such a prolongation of the transition setup with a unanimous European Council decision, while it is more debatable whether BoJo can live with a prolongation. We expect the GBP to weaken in such a scenario but nothing out of the ordinary," Larsen says.

Negotiations will continue Monday as the UK's Internal Market Bill returns to the House of Commons following amendment in the House of Lords, which removed terms that allegedly breached the EU Withdrawal Agreement's provisions relating to Northern Ireland in the event of a 'no deal' Brexit. 

Those terms had angered the EU, although the danger is that Downing Street reinserts them back into the bill in a bid to put pressure on Brussels, which risks backfiring by souring the atmosphere between the two sides and pushing an agreement further out of reach. 

"A trade deal already appears well priced into the GBP. We see only modest initial upside (2% to 3%) if a deal is reached," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. "In contrast, it would be a much bigger shock for the GBP if they fail to reach a deal. In that scenario we expect the GBP to fall sharply (-6% to -8%) resulting in cable falling back to the mid-1.2000’s." 

Halpenny's warning of a 1.20 GBP/USD rate in the event that a 'no deal' exit from the transition on December 31 becomes the default implies a Pound-Euro fall to around 1.03.

However, such levels might not materialise instantly, not least of all because the two sides still have days before the December 10 European Council summit where EU leaders were hoping to be able to sign off on an agreement.

Above: Pound-to-Euro rate shown at daily intervals.

"We are still inclined to think a deal will be agreed," says Petr Krpata, chief EMEA strategist at ING in a Friday note to clients. "Our view is that the deal will be a “skinny” one, mostly focusing on trade rather than services and leaving a certain degree of uncertainty for UK business. Should this be the case – and considering markets have maintained an optimistic stance on a deal - we may see cable’s rally contained in the 1.37 region, and EUR/GBP running out of selling pressure below the 0.8900 mark [GBP/EUR: 1.1235]."

Even after this week, political leaders would have weeks for the December 31 end to the standstill transition period that keeps World Trade Organization (WTO) wolves from the door and Most Favoured Nation tariff rates from the imports and exports travelling back and forth across the English Channel.

As a result much about the scale of Sterling's immediate losses in the week ahead could be determined more than anything by the tone of Boris Johnson and his Brussels counterpart on Monday evening, and whether efforts to reach an agreement are prolonged beyond then if one has remained elusive.

"The reality is that there are no hard deadlines in politics, why some sort of no deal but no tariffs scenario is still a possibility," says Nordea's Larsen. "In an adverse no deal scenario, the UK needs to implement EU tariffs on EU to comply with WTO fairness rules, which would lead to surging prices on everyday goods such as food products. Would BoJo really want to be known as the breakfast- or bacon slayer? We doubt it, why a final minute no deal but extension of no tariffs scenario seems more likely."

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Brexit politics will be a burden for the Pound that offsets at least in the early stage of the week ahead, an otherwise positive backdrop that could also see the Pfizer and BioNTech coronavirus vaccine begin to be rolled out in the UK. However, the Euro will not be without its own challenges either.

"We still believe a deal is more likely than not and that the days ahead of the EU summit on Thursday are extremely important," says Piet Haines Christiansen, chief analyst at Danske Bank. "Last week EU diplomats said the rift with Hungary and Poland on the NGEU budget and the rule of law is getting worse. Our baseline remains that they will find a solution (60%), as there are strong interests on both sides (countries need money and stability, not political chaos and market turbulence), however, we also acknowledge a risk of a delay to a solution. The adverse scenario of no solution has the potential to trigger a significant political crisis in the EU."

Europe's single currency is close to three year highs against the Dollar and could be susceptible to softness itself ahead of Thursday's event-filled calendar that sees the European Central Bank (ECB) "recalibrating" its monetary policy settings as EU leaders hope to resolve a near-five year Brexit Saga as well as an ongoing row closer to home, over its next budget and widely anticipated as well as eagerly awaited coronavirus recovery fund. 

Any investor unease over the outcome of the above events that becomes reflected in EUR/USD would offer a consolation to a Pound-to-Euro rate that fell back to early November lows beneath 1.11 last week, given that GBP/EUR always closely reflects relative price action in GBP/USD and EUR/USD.

Above: Pound-to-Euro rate shown at weekly intervals.

Technical analysts at Commerzbank remain bearish on Sterling, tipping it for a fall toward 1.0928 this week. Their one-to-three month forecast also remains for a fall to 1.0726, which would be the Pound's lowest since March.

"EUR/GBP has recently eroded its 2 month down channel and yesterday retraced some of those gains. We look for a move to .9150, the October 20 high and there is scope for the .9308 2017 high and .9323 to be reached longer term. This is the location of the 78.6% Fibonacci retracement," says Karen Jones, head of technical analysis for currencies, commodities and bonds.

Other potential influences on the Pound this week could include UK GDP data for October, European politics and the European Central Bank.

Consensus looks for GDP to have risen 0.4% that month following a 1.1% increase in September however, the subsequent national lockdown in November and enhanced restrictions through December mean a contraction almost certainly beckons for the final quarter and could limit the impact on Sterling.

The data is due out at 07:00 on Thursday, alongside other figures including manufacturing production and construction output. The ECB's monetary policy decision is due out at 12:45 London time on Thursday while the European Council meeting continues through Friday.

"The ECB monetary policy meeting and possible completion of UK-EU trade negotiations with confirmation of a deal will be the focus for the markets next week. We doubt the ECB policy announcement will hold any surprises with an extension of PEPP likely – some comment on EUR is likely but the ECB’s scope to influence direction is limited. The finer details of a trade deal will determine how much further GBP can advance," says MUFG's Halpenny.