Upside Potential for British Pound Building: RBC Capital

© Photocreo Bednarek, Adobe Stock

- GBP downside "limited" in December says RBC Capital Markets.

- Upside risks for GBP building, aided by recent events in parliament.

- Voting down PM May's deal could easily backfire on Brexiteers.

- Pound-to-Euro rate @ 1.1211, Pound-to-Dollar rate @ 1.2711

Hopes of Prime Minister Theresa May's Brexit deal being voted into the statute book on December 11 have been boosted on reports her government plans to entice 'Brexiteer' MPs to support her deal with an Irish backstop 'parliamentary lock' plan that would effectively give MPs a vote before any backstop could be implemented.

The move, while not expected to trigger a sea-change in support for the deal could narrow the scale of the loss the government suffers on December 11 when the deal is voted on.

"We do think it is closer to a 50/50 call than the 15/85 that markets appear to price," says Adam Cole, an analyst with RBC Capital Markets, referencing the deal's prospects of passing through parliament

"And it is not difficult to argue GBP would take this outcome positively. One week volatility has spiked today as it incorporates the vote, but one week riskies have relatively small premium for puts, which does suggest investors may be starting to contemplate short-term upside risks," says Cole.

The Pound will have to endure a volatile December that could yet result in punishing losses if things go the wrong way for the government, but the overall risk for Sterling is now tilting toward the upside says Cole. 

"What will happen to GBP if the Commons rejects PM May’s Brexit bill next Tuesday? It probably depends on the margin by which it fails, but the downside for GBP in anything other than a catastrophic failure scenario looks limited and it is becoming easier to identify the upside," says Cole.

Prime Minister Theresa May's predicament is well known in that after having agreed terms of the UK's March 29, 2019 exit from the EU, there appears to be too few MPs in the House of Commons who are willing to vote it onto the statute book. 

As a result currency traders have been readying themselves for a seemingly inevitable defeat of the government when the House of Commons gets its "meaningful vote" on the Withdrawal Agreement on Tuesday 11, December. 

Sterling is the worst-performing major currency of the past month and trades towards the lower end of long-term ranges against the likes of the Euro:

Above: Pound-to-Euro exchange rate shown at daily intervals.

1 GBP buys 1.1233 EUR at the time of writing, high-street banks are offering exchange rates in between 1.0950 and 1.1030 for international payments and transfers, independent providers are offering in a range of between 1.1140 and 1.1150.

1 GBP buys 1.2736 USD, high-street lenders are offering rates of between 1.2390 and 1.2480 while independents are offering between 1.2620 and 1.2647.

Lawmakers on all sides of the House of Commons have pledged to vote against the proposals for a variety of reasons and the PM is currently expected to lose the ballot in the Commons.

Approval of the Withdrawal Agreement before March 29, 2019 is key if the UK is to avoid leaving the EU without any preferable arrangements in March 2019 and defaulting to trading with the bloc on World Trade Organization (WTO) terms. 

Objections to the deal are legion and they vary in nature while also transcending party lines, to an extent that there isn't a majority for anything related to Brexit in the House of Commons. Cole and the RBC team say recent developments have increased the incentive for supporters of an EU exit to fall into line and back the government.

"We have always argued that a Eurosceptic strategy of voting the bill down in order to engineer an exit with no deal runs a risk of backfiring if it results in either a lost election, or a second referendum. And events this week have brought this risk into even sharper focus, opening the possibility of the UK unilaterally revoking Article 50 and potentially increasing Parliament’s role in reshaping Brexit if the bill does fail," Cole writes.

The EU Advocate General this week advised the European Court of Justice the UK can unilaterally revoke the Article 50 notification that set the ball rolling on the process of exiting the EU. It is expected the ECJ will deliver on this recommendation in a move that will likely embolden the 'remain' contingent in parliament and pressure 'Brexiteers'.

Further, some of the government's pro-remain antagonists in the House of Commons won on Tuesday an amendment that they claim will give them and the heavily pro-European Union parliament greater control over the Brexit process if the government loses the Withdrawal vote next Tuesday.

Seperately, the Times reports that some cabinet members are even pushing for a delay to the Brexit vote amid fears that the defeat would be so catastrophic it could bring down the government.

Key Brexit Updates

ECJ Ruling Due Early Monday:

The European Court of Justice will rule Monday on whether the UK can unilaterally halt Brexit, potentially offering a boost to those opposed to leaving the European Union just a day ahead of a crucial vote on the Brexit deal agreed between the EU and UK in parliament.

The ECJ said a ruling would come at 8:00 GMT. This week the European Union's Advocate General recommended to the ECJ that the UK could withdraw unilaterally. The ECJ has followed Advocate General guidance in 80% of cases.

Barclay says UK Ready for a 'No Deal' Brexit:

The UK will be ready for a no deal Brexit by March next year but significant work will be required, Brexit minister Stephen Barclay said on Thursday.

"Yes, we will be ready but significant work will be required," Barclay told parliament.

Uncertainty to Weigh on Sterling Ahead of Key Vote: ING

While RBC Capital say it is now easier to potential upside in Sterling going forward, we are reminded by others short-term pressures are likely to persist.

There is a significant amount of uncertainty for currency markets to contend with and we believe the Pound will likely tread water until the scale of the defeat suffered by the government in next week's vote is made clear.

In keeping with the current parliamentary theme, there isn't much of a majority or consensus for anything in the currency analyst community either. Except that most agree a 'no deal Brexit' would do little good for the Pound, in either the short or longer term, and that the UK is unlikely to ultimately end up with one under almost any circumstance imaginable.

Above: Pound-to-Dollar rate shown at daily intervals.

One popular narrative is that a rejection of the agreement by parliament would see the threat of a "no deal Brexit" rise, but that MPs will eventually approve the Prime Minister's pact after a period of carnage in the foreign exchange and stock markets has had time to chip away at the resolve of the bill's opponents. 

Although Cole is sceptical of how much lower the Pound will go this year, the British currency has already underperformed rivals in the early part of the current week as MPs remained staunch in their opposition to the Withdrawal Agreement.

Other analysts have however warned Sterling could fall much further than it has done if parliament rejects Prime Minister Theresa May's deal next Tuesday.

"The highly divisive UK politics and the veil of uncertainty about the Brexit outcome should continue weighing on GBP," says Petr Krpata, a strategist with ING Bank N.V.

ING note that still a fairly limited short term risk premium is priced in the EUR/GBP (currently modestly above 1% vs 3-4% in late August this year).

"This suggests more downside to GBP stemming from the next week’s (likely unsuccessful) vote on the Brexit deal. EUR/GBP to move above 0.9000 in coming days," says Krpata.

A EUR/GBP exchange rate at 0.90 gives a Pound-to-Euro exchange rate of 1.11.

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