Pound-to-Euro Exchange Rate Below Parity or Back Above 1.33? The Politicians Will Choose

Above: Angela Merkel says the road to closer UK-EU integration after Brexit date is something she would welcome. Image © European Council.

- Rabobank, UBS confirm path forward for Sterling still highly ambivalent

- Pound-Euro below parity on hard-Brexit

- Retaining single market access could see exchange rate back to 1.33

Expectations for the type of Brexit we can expect continue to evolve with the headlines, and with these changing expectations naturally come shifts in forecasts for the British Pound.

Brexit headlines over the past 24 hours confirm the shape of the final outcome remains fluid with UK Foreign Secretary Jeremy Hunt warning that "everyone needs to prepare for the possibility of a chaotic 'no deal' Brexit" and German Chancellor Angela Merkel saying “hopefully it will not come to an unregulated Brexit, but rather to a reasonable, negotiated agreement.”

For Pound Sterling, whether the outcome is chaotic or negotiated is absolutely critical with the currency tipped to fall to "parity or beyond" in the event of a chaotic outcome.

The expectations for the Pound serve as an important reminder to those with sizeable currency requirements over coming months that the prospect for huge moves in the Pound remain possible.

The value of Sterling going forward "is struck on a binary path, though the market’s approval or disapproval of political outcomes can clearly still be reflected in how far the pound moves. We anticipate that a hard Brexit has the potential to take EUR/GBP to parity and potentially beyond," says analyst Jane Foley with Rabobank in London.

However, "by the same token retained access to the customs union and single market by the UK post Brexit would wipe out a huge degree of uncertainty for businesses," adds Foley.

Foley says under membership of a European customs union and/or the single-market the Pound-Euro exchange rate could potentially rise to 1.25-1.33.

Further comments from Merkel made on Tuesday, August 14 at a 'town hall' style event saw her tell an audience, "the exit agreement cannot be static. If Britain wants to benefit (from the EU in the future) it must commit to re-accepting EU rules."

Clearly she sees the road ahead open to a closer EU-UK relationship and the relationship as being one that will continue to evolve.

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The EU-UK relationship of course relies greatly on domestic UK politics; which party is in control and which faction of the Conservative party is in control.

Here there is significant uncertainty with Prime Minister Theresa May set to have a showdown with the 'pure' Brexit wing of her party over coming months. Reports suggest May has been looking to secure support within the Conservatives for her 'Chequers Plan' but it does continue to face resistance.

It has been reported that Conservative Brexiteers plan to challenge Theresa May directly by publishing their own “positive” blueprint for a 'no deal' Brexit.

A policy paper, due for publication next month, is being established by a group of Brexiteers that seeks to outline the advantages to Britain of leaving the European Union on World Trade Organisation terms.

It is expected to have the backing of 60 to 80 Conservative MPs, increasing the pressure on the prime minister before the party conference in Birmingham.

Although the paper is still being developed it is understood to allow for a possible Canadian-style free trade agreement, but only if the EU backs down on demands over the Irish border.

This pressure only adds to the market expectation that a 'no deal' Brexit remains a distinct possibility as this tranche of Conservative party MPs do have the numbers to wield influence over the type of Brexit agreement that is ratified by Parliament.

The rising of 'no deal' risks has been a feature of foreign exchange markets this August and has corresponded with a decline in Sterling to multi-month lows against both the Dollar and Euro.

May therefore will find herself negotiating with both her party and Europe, and Sterling will remain uneasy about this.  

The Pound-Euro exchange rate is forecast to remain under pressure over the next three months as the Brexit story plays itself out and Daniel Trum, Strategist with UBS, says it should fall back down to the 1.11 region over this time period.

"We still believe it is more likely than not that a deal will be eventually found," says Trum who forecasts the Pound-Euro exchange rate to rise back to 1.1360 over the next 12 months.

Markets are clearly still giving the Pound the benefit of the doubt, but if a 'no deal' Brexit becomes the expected outcome it could well be Foley's parity forecast that wins the day.

"A cliff-edge Brexit, i.e. no agreement on a transition deal, could seriously hurt Sterling beyond our forecasts," acknowledges Trum, who adds the GBP is facing the proverbial "fork in the road."

The Pound-to-Euro exchange rate trades above 1.12 in the mid-week period as it establishes a modicum of support having broadly been in decline since April.

The UK currency remains prone to losses and we note in a recent technical study that this week requires a positive close for the exchange rate to indicate it is in fact reversing from a short-term down trend.

In the immediate term, we watch for the outcome of this week's Brexit negotiations. There are as yet no indications that there will be any official set-pieces for the media on Thursday when talks are expected to conclude.

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