Pound-Euro Forecast to Fall Anywhere Between 1.05-0.95 if Brexit Talks Fail

- A big move is coming says Soc Gen
- With the bigger move to the downside
- Capital Economics warn of slump to below parity on 'no deal'

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• GBP/EUR spot rate at time of publication: 1.1020
• Bank transfer rate (indicative guide): 1.0730-1.0812
• FX specialist providers (indicative guide): 1.0902-1.0940
• More information on FX specialist rates here

Pound Sterling is forecast to fall sharply should the EU and UK fail to agree a post-Brexit trade agreement, with one analyst saying the decline could see the Pound-to-Euro exchange rate fall below parity.

Foreign exchange market participants are keeping the Pound in a holding pattern as they await the outcome of a meeting between UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen.

The meeting will take place in Brussels at some point this week, with political commentators and analysts saying that it would most likely come on Wednesday, a day before EU leaders are to meet at the European Council summit.

An easy majority of foreign exchange analysts are in agreement that the Pound will rise if a deal is reached, but fall if talks end in failure.

However, the upside potential is substantially smaller than the downside potential based on options market data.

"There is much more downside risk to the Pound than upside," says Thomas Pugh, UK Economist at Capital Economics.

"We think a UK-EU trade deal narrowly remains the most likely outcome of talks, which should lead to an eventual but modest GBP rebound. We reiterate what we see as an asymmetric GBP reaction function to the UK-EU trade negotiation outcome, with modest upside in the case of a deal but profound downside in the event of no deal as fairly limited risk premium is currently priced into GBP," says Francesco Pesole, FX Strategist at ING Bank.

Buying insurance against a downside move in the Pound is substantially higher than the insurance for an upside move in the Pound, suggesting the market sees notably more downside potential.

Where market participants are buying protection in turn gives a solid idea as to how far the Pound could fall or rise in the event of a deal or no deal outcome.

Kit Juckes at Société Générale says the bets for downside protection exceeds bets for upside protection by the most since the June 24 2016 EU referendum.

At the time the Pound-Euro exchange rate fell from 1.2980 ahead of the result to 1.1630 following the result.

"The surprise is that the spot market is only reacting half-heartedly. Such a binary outcome as we are now facing, with Boris Johnson heading to Brussels for last-ditch talks and both sides urging the other to give ground, is bound to trigger a significant move," says Juckes.

Juckes says the outcome will come in mid-December as markets liquidity thins as traders exit the market around the Christmas break. Thin market liquidity tends to exaggerate moves in financial assets as it becomes harder to match buyers and sellers.

This, "just adds to the jeopardy," says Juckes.

The Soc Gen analyst says he thinks we're likely to see 1.05 in GBP/EUR if the search for a deal is called off.

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"And with the market leaning that way, I wouldn't be surprised to see EUR/GBP back close to 0.85 before too long, if a breakthrough is achieved," says Juckes of EUR/GBP. (EUR/GBP at 0.85 gives a rally to 1.1765 in GBP/EUR).

"The only thing I don't know, is how to place odds on these two outcomes," says Juckes.

Capital Economics forecast the Pound-to-Dollar exchange rate would likely rally to 1.35 in the event of a deal, while the Pound-to-Euro exchange rate could rise to 1.13.

However, in the event of a 'no deal' outcome the Pound-to-Dollar could go down to 1.15 while the Pound-to-Euro could fall to below parity to 0.96.

A real risk to the outlook for the UK economy and the Pound is that any 'no deal' outcome proves to be an acrimonious one say Capital Economics, who identify that not only is there a 'deal or 'no deal' outcome to negotiations, but there is a "cooperative no deal" and an "uncooperative no deal".

>> Time to Buy Pound Sterling, Sell the Euro: Westpac

In a "cooperative" outcome both sides would work together to minimise the negative impact of a 'no deal', while under an "uncooperative" outcome the UK and EU would fall into a series of legal spats and "completely fall" out, according to Pugh.

One of the routes to an "uncooperative" outcome would be via the UK passing legislation that would override elements of the Withdrawal Agreement regarding the Northern Ireland protocol.

The UK government announced on Monday, Dec. 07 that they would eject those elements of the Internal Markets Bill which would break international law and sour relations with the EU if passed, provided a trade deal is agreed.

Therefore, on what the government has said, the offensive clauses will make a comeback if the two sides fail to reach an agreement, suggesting a worst case "uncooperative" no deal would be on the cards.

This would likely drive Sterling to the lower end of the Capital Economics forecasts.