Pound Sterling Holds Advance on Report of new E.U. Concession on Irish Backstop, Near Highs vs. Euro and Dollar

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- E.U. said to have conceded ground on Irish backstop

- Market confidence for year-end Brexit deal grows

- GBP bulls "in the drivers seat" for now

Pound Sterling will be looking to defend recent advances against the Euro and U.S. Dollar ahead of the weekend with our latest studies suggesting a period of consolidation is likely following the sharp moves of late.

Over the past 48 hours the currency has recouped much of the October losses suffered against the Dollar and Euro; to put the moves into perspective, since 2008, the GBP/USD exchange rate has risen more than 1.9% in only 4 other occasions.

The Pound is almost exclusively focussed on Brexit negotiations at present with a drip-feeding of rumours triggering the recent recovery move and further advances will require further good news ensuring the currency will remain volatile on a day-to-day basis.

We have further developments on Brexit ahead of the weekend with the Financial Times reporting the E.U. is ready to offer the UK a “bare-bones” U.K.-wide customs union with the E.U. in the event of the Irish backstop being triggered.

Should negotiations over the future trading relationship fail to deliver a frictionless Irish border during the two-year transition period then the backstop would come into play: it would operate until a permanent trade agreement between the U.K. and E.U. is agreed, thereby guaranteeing no hard border between the Republic and Northern Ireland.

Crucially, the U.K.-wide backstop negates the need for Northern Ireland and Great Britain to fall into separate trading jurisdictions ensuring domestic resistance to the backstop is mitigated and therefore allowing progress towards a deal to continue.

Previously, the E.U. had said such a U.K.-wide customs union would have to be in a separate treaty based on a legal argument that it is outside the scope of Article 50, which would take
much longer to conclude as it would have to deal with “level-playing field” concerns, among other things.

"If confirmed, the latest E.U. proposal would represent a significant concession," says Chiara Silvestre, an Economist with UniCredit Bank in Milan.

The Pound is sensitive to any signs of progress towards a Brexit deal being concluded and this news is therefore supportive and adds to a rally sparked by a Times report the U.K. and E.U. had settled on a deal that covers the trade in services.

The Pound-to-Euro exchange rate is seen hovering just below the 1.14 level, having been as low as 1.1184 earlier in the week. The Pound-to-Dollar exchange rate is seen maintaining ground above the psychologically supportive 1.30 level, having been as low as 1.2696 earlier in the week.  

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"The British currency remained well supported by hopes over a Brexit deal. Following the reports that the UK and the EU have struck a tentative deal on financial services, another report yesterday said that the EU is exploring a compromise on an Irish border plan. Despite remarks by Theresa May’s spokesman that the reports over a services deal were speculation, the latest report kept GBP-bulls in the driver’s seat," says Charalambos Pissouros, Senior Market Analyst with JFD Brokers.

UniCredit's Silvestre cautions that it remains unclear whether the U.K. government is ready to accept such a proposal, given that the E.U. is still insisting on a “backstop to the backstop” whereby only Northern Ireland would remain in the E.U. customs union (applying the full EU customs code) and the single market for goods.

"Our view is that the makings of a deal are now close, but it probably will not be done until December given that even a temporary “bare-bones” U.K.-wide customs union with the E.U. would take time to conclude," says Silvestre.

We have seen Sterling retreat from the highs registered earlier in the day ahead of the market close and believe traders are not yet ready to chase the Pound higher just yet as they will want more than just rumour and speculation to drive a major break to fresh multi-month highs in Sterling.

"Headlines on Brexit will intensify, but short of a material sign that negotiations are progressing (or that we are heading towards a ‘no deal’), they are unlikely to trigger a decisive directional shift in Sterling," says Daniel Been, Head of FX Research with ANZ Bank.

Next Moves for the Pound

We believe Sterling is likely to strike a sideways tone until a real, concrete outcome to Brexit negotiations are made. Therefore. Further trade in established medium-term trends should be expected over coming weeks with sharp spikes higher and lower within that range.

Against the Euro, we look for Sterling to be capped at around 1.1460 with any moves into this region likely to encounter selling pressure. The longer-term fulcrum is at 1.1250 and the currency could well retreat back towards these levels.

Above:GBP/EUR approaches the top of a long-term range. Image (C) TradingView.

The Pound-to-Dollar exchange rate is a little more tricky to call though, owing to the widespread U.S. Dollar selling seen of late. While the the Pound has enjoyed a good run, Dollar weakness could account for a huge chunk of the move in USD.

"The Pound’s strength is at least 50% a dollar weakness story – a snapback in the dollar’s fortunes would make that 1.30 handle look untenable," warns Neil Wilson, Chief Market Analyst at Markets.com.

Above: The Dollar index - a measure of overall Dollar performance - has fallen sharply over recent days. Image (C) TradingView.

"While the initial reaction to the tentative turn around in sentiment at the start of this week was for the USD to strengthen across the board thanks to the recovery in U.S. yields, it’s noticeable that this pattern has changed since the middle of the week," says Simon Derrick, Chief Currency Strategist at BNY Mellon.

BNY Mellon sees similarities in the behaviour of the Dollar now and the Dollar when it ended its two previous major rallies.

The implication is that a period of longer-term Dollar strength might be ending; this bodes  for GBP/USD strength ahead, particularly in the event of a Brexit dealing being struck and a smooth exit being secured.

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