British Pound Defends Key Level vs. Euro, "Substantial" Shift in UK Position on Brexit Talks Hints to Positive Surprises Ahead

"We see increased upside risks for the Pound due to clear signs of progress being made toward a financial settlement that could result in transition and trade talks beginning in January." - MUFG.

It's happened again - the market has refused to let the Pound fall to below 1.11 against the Euro which tells us something about the immediate outlook for the Pound-to-Euro exchange rate.

Sterling went down 1.0% against the Euro in during the course of the week ending November 17, but that the conversion ended at 1.1190 confirms range-bound trade remains the theme of the moment.

And, simple technical studies of the market suggest we might expect more of the same over the course of the next week.

Technical analysis is the study of a particular market's underlying structure through the use of price charts; by looking at charts we can identify patterns that tell us how traders are thinking.

We are able to learn where buying and selling interest is likely to be found as traders will also look at a chart and make assumptions about their fellow market participants' future behaviours.

Of course this is not an exact science, but sometimes compelling messages are delivered.

In the case of the Pound-to-Euro exchange rate, that message is Sterling will struggle to depreciate below €1.11:

Above: History repeats as the Pound-to-Euro exchange rate bounces back above the key level at 1.11.

Or, from the other side, the Euro will struggle to appreciate beyond £0.90.

"The topside test looks rejected for now," says analyst Piet Lammens at KBC Markets in response to the Euro's failure to hold its latest advance against the Pound. "The UK currency was supported by the better overall risk sentiment. Yesterday’s potential trend reversal signal in EUR/GBP (and in EUR/USD) also weighed on the Euro cross rates."

(Recall our recent article that suggests the Pound vs. Euro is being driven by moves in Euro vs. Dollar? It's worth keeping an eye on this dynamic!)

We also wrote earlier in the week that the Euro would struggle to make ground on the Pound owing to the setup in the bond markets - a key driver of exchange rate value; this call appears to have been correct and could help explain Sterling's stubbornness.

Pushing the Euro higher against the British Pound would amount to "pushing a stone up a hill" in the words of long-time City foreign exchange analyst Kit Juckes of Société Générale.

Juckes has studied a traditional driver of the Euro vs. Pound exchange rate - interest rate differentials. The interest rates being referred to here is the yield paid by German and UK sovereign debt; the differential is the difference between the two.

The above image from Deutsche Bank confirms the linkage between the EUR/GBP exchange rate and the spread between German and UK bond yields. German yields are lower than UK yields, this in turn sees investor cash flow from Germany to the UK, supporting the Pound in the process.

However, the recent dislocation has economists at Deutsche Bank describing the Pound as cheap, something Juckes concurs with.

“The level of relative rates at the front end of the curve is very strongly tilted in Sterling’s favour, and while I don’t think that matters much, it does mean that pushing EUR/GBP up is a bit like pushing a stone up a hill,” says Juckes. “Not the full Sisyphean ‘push it up and then get flattened when it rolls back down’ metaphor but hard work all the same."

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Too Risky to Sell the Pound with Key Update on Brexit Negotiations Looming

It appears traders are simply not willing to sell the Pound in case some good news comes out of Brexit.

"Investors don’t want to be positioned aggressively sterling short as more constructive Brexit news remains possible," says Juckes.

For Sterling, much hinges on what progress can be made in the lead-up to the December EU summit on Brexit; European leaders will decide whether or not enough progress has been made on the first round of negotiations in order to press on to talks of trade and the future relationship.

Businesses desperately need clarity, and talk of the future will provide that, Sterling will respond accordingly.

"We see increased upside risks for the Pound due to clear signs of progress being made toward a financial settlement that could result in transition and trade talks beginning in January. We will get a better sense of any progress that has been made when PM May meets with European Council President Donald Tusk at the EU summit in Sweden later today," says Derek Halpenny at MUFG.

According to Manfred Weber - the head of Europe’s centre-right MEPs in the European Parliament and a close ally of German Chancellor Angela Merkel - UK Prime Minister Theresa May is close to offering a deal on payments that would unlock Brexit negotiations.

Weber said he had received “positive messages” during a meeting in Downing Street mid-week.

Weber told reporters he had witnessed a substantial shift in the British approach which might now allow EU leaders to move on to the next stage of negotiations.

Following a meeting held with Theresa May, David Davis and Amber Rudd, Weber notes:

“I am one of the more sceptical partners from the European parliament side on Brexit negotiations and ongoing progress but I have to say that after my meetings today my main message is that I am more optimistic that there is progress; that there is the will to see progress.

“The message is that the will is there.

“That is the most important thing, because the perspective from a European point of view toward London was that in the last month or two there was not. After my meeting I have more certainty about the general direction and that is positive.”

For a currency that is so closely tied to political gyrations, this development is supportive.

"We are still taking as our base case a view that the UK finds a way to promise sufficient clarity on the financial settlement to allow for a positive surprise, which is the key to our relatively bullish GBP forecasts,” says Shahab Jalinoos, a foreign exchange strategist at Credit Suisse.

Credit Suisse's latest forecasts can be found here.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.