Parity Warnings for Pound-to-Euro Exchange Rate on 'No Deal' Brexit

Above: Markets are still expecting Dominic Raab and Michel Barnier to strike a Brexit deal. Image © European Union, 2018 / Source: EC - Audiovisual Service / Photo: Lukasz Kobus

- Cost of hedging against 'no deal' Brexit surges

- GBP down as markets increase assumptions a 'no deal' Brexit likely

- But, GBP/EUR still at levels consistent with markets ultimately believing a deal will be made

- A break towards parity forecast to occur if no deal actually materialises

Pound Sterling has fallen to an eight-month low against the Euro in midweek trade with one Pound buying 1.1129 Euros at one point. The last time we saw rates this low was back in November 2017.

Data reveals the cost of hedging against a 'no deal' Brexit by corporates looking to protect their currency exposure continue to rise "relentlessly" says Richard Pace who sits on the Thomson Reuters currency desk. "Nine-month and one-year contracts have seen relentless demand."

It is these longer-dated options which "truly reflect the rising concern about a no-deal Brexit," says Pace as their expiries falling after the planned March 29, 2019 Brexit date and therefore capture any related volatility and deeper GBP declines.

We are told the British Pound could well fall to an equal value with the Euro should the UK and EU fail to reach a Brexit deal warns a prominent foreign exchange analyst.

The suggestion that the Pound-to-Euro exchange rate could reach a 1:1 exchange rate comes from Jane Foley, Head of FX Strategy at Rabobank in London, at a time when foreign exchange markets are seen to being increasingly factor in the prospect of Brexit negotiations ultimately failing.

EU and UK leaders are eyeing the October 18 European Council Summit for a deal to be struck in time for the March 2019 Brexit day. But, with limited time left to negotiate and increasingly entrenched positions on both sides of the table markets are inevitably becoming increasingly concerned no deal will be reached.

"This is all about politics now for the Pound," says Foley.

The Pound's performance against the Euro is widely considered to be the purest expression of Brexit angst on the foreign exchange market; and the exchange rate's decline from an April 17 high of 1.1599 to today's 1.13 is an expression of heightened nerves.

The downtrend leaves us eyeing the July 20 low at 1.1164 as the next obvious downside target but beyond here the August 2017 low of 1.0746 beckons.

It is important to point out that the exchange rate is still within the confines of a well-defined trend that has been in place since September 2017 and it has in the past been lower; a reflection that markets are still more-or-less expecting a deal.

There is therefore a substantial degree of downside ahead should the EU and UK fail to reach an agreement and a 'no deal' Brexit is fully priced in.

"Although it is not our central view, we would anticipate that a hard Brexit would drive EUR/GBP towards parity and this would trigger another round of damaging inflationary pressures in the UK," says Foley.

Foley says markets are however ultimately prepared to see some brinksmanship from politicians who will keep on "pushing, pushing and pushing" their position "until finally they sign on the bottom line".

Rabobank expect "political uncertainty to erode support for GBP in the coming weeks and expect EUR/GBP to trade back up to 0.89 on a 1 month view."

An EUR/GBP exchange rate at 0.89 gives a Pound-to-Euro exchange rate of 1.1236.

Therefore the market is forecast to maintain current levels over the coming month.

We wrote at the start of this week that Sterling would likely consolidate in the month of August as Brexit headlines dissipate owing to politicians on both sides of the channel taking their summer holidays.

We stand by this view, however interventions such as those made by senior UK minister Dr. Liam Fox that the chances of a 'no deal' Brexit now start at 60-40 cannot be ruled out.

The Pound took a leg lower on Fox's intervention which appears designed to tell Europe that the UK has little further ground to concede and that the prospect of a 'no deal' therefore remains high.

There is certainly a sense that the European will need to offer some leeway if a deal is to be made, and for Sterling, signs of such leeway can't come soon enough.

"With summer conditions in full force, the MPC a long way from another hike (we anticipate another 9 months from now at the earliest), we look for domestic politics and external factors for GBP direction," says Mazen Issa, Senior FX Strategist at TD Securities. "We think that the market will be inclined to sell GBP rallies."

At the time of writing one Pound buys 1.1174 Euros on the inter-bank market with banks offering a rate between 1.0780 and 1.0860 for international payments. Independent FX providers are seen offering above 1.1073.

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