British Pound Holds its Nerve Despite "Seismic Decision" by Government to Implement No-Deal Brexit Plans in Full

Image © Number 10 Downing Street, image edited from original by Pound Sterling Live

- Government implements no deal plans 'in full'

- No smooth landing in 'no deal' Brexit scenario warn EU

- Retail sector slowdown heralds weaker UK economy at year-end

- Pound-to-Euro exchange rate at 1.1106, Pound-to-Dollar rate at 1.2661

The British Pound is one of the better performing major currencies on Tuesday, December 18, enjoying gains against the majority of its G10 competitors. Gains against the Dollar are particularly notable, however the advance is flattered somewhat by a broadly weaker U.S. Dollar which has taken fright over a recent slowdown in U.S. economic activity.

Furthermore, markets will be unwilling to buy the Dollar ahead of the key U.S. Federal Reserve meeting mid-week, so we could well see the Pound benefit near-term.

Domestically, the political agenda remains of key importance for Sterling with all eyes now turning to the Brexit vote to be held mid-January. However, we should get signs of how that vote might proceed, as well as any alternatives to May's Brexit deal, emerge before then.

So keep an eye on the headlines as markets tend to move when you least expect them to.

1) Government Implements No Deal Planning 'in Full'

The UK Government has on Tuesday, December 18 implemented its no deal Brexit planning in full with Brexit Secretary Stephen Barclay has said preparing the UK for a 'no-deal' Brexit is now an "operational priority".

"There are 320 workstreams across Whitehall on no-deal with each workstream likely containing numerous plans," reports Jack Maidment, Political Correspondent at The Telegraph who describes the move as a "seismic decision".

According to reports, at today's cabinet meeting it was agreed that with just over three months until the UK's exit from the European Union the point has been reached at which preparations must be ramped up.

The government will be sending 80,000 emails to key business stakeholders in the coming days to tell them what no-deal means for them. They will be pointed to a 100 page document with all the information.

The government is also going to be telling citizens what they need to do ahead of no-deal. "Civil servants will be working over Christmas to get all this no-deal stuff up and running before March 29, 2019," reports Maidment.

To us it looks as though 'no deal' Brexit planning is being taken more seriously than ever; while planning is always welcome a 'no deal' Brexit will put the British Pound under great pressure in early 2019.

For now, markets appear inclined to believe that such an outcome will be avoided, evidenced by the fact Sterling is up on the day against most currencies.

Indeed, analysts are increasingly of the opinion that the most likely outcome in March 2019 is that the UK extends the Article 50 process, in order to buy further time. 

"We believe that MPs would either legislate to extend the Article 50 period (where the UK continues to temporarily remain in the EU) or revoke the Article 50 notice, pending greater clarity on the way forward. In each case the status quo would continue," says Mike Amey, Head of Sterling Portfolio Management and ESG Strategies at PIMCO.

PIMCO believe markets are now broadly priced for an extended period of the status quo – where the current impasse remains, but the UK remains in the EU.

2) No Managed 'No Deal' say EU

The European Commission has meanwhile said there will be no managed 'no deal' process triggered if it becomes clear the UK and EU are heading for a 'no deal' Brexit.

The European Commission say they will put forward measures to reduce the worst damage of a 'no deal' Brexit when it publishes delayed contingency plans for Britain crashing out of the EU on Wednesday but will rule out any British hopes of a "managed no deal".

The strategy will, if backed, allow the EU will unilaterally declare the extension of agreements in selected sectors for between six to nine months to give its member countries time to strike bilateral agreements with Britain.

We see such an outcome as representing a chaotic 'no deal' and on paper this represents the worst possible outcome for the Pound: under such a scenario the initial knee-jerk decline in the currency could be quite substantial.

We have held an assumption that the two sides would work together to mitigate against any unruly Brexit in a so-called managed 'no deal'.  We believe this is a case of the EU putting further pressure on Britain's parliamentarians to back the deal struck between the EU and UK in November.

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3) Confidence Vote in May a Non-Starter for the Pound

Jeremy Corbyn on Monday called for a parliamentary no confidence vote in Prime Minister Theresa May after flip-flopping on the issue: He threatened a no confidence vote in May if she did not set a date to vote on the Brexit deal. May did call a date, but Corbyn then decided to push ahead with the vote in the face of pressure from his party.

The vote is non-binding and the government doesn't even need to agree to it leading to accusations of grandstanding by the Labour leader.

Reports suggest Theresa May has upped the ante on the Labour Party by inviting them to call a more serious vote of no confidence in the government. A no confidence vote in the government is binding and if the government loses fresh elections would be called.

In both the above, the DUP would vote with the government, therefore we see it as being of little consequence to the value of the British Pound near-term. If anything, May knows a win on any confidence vote would likely strengthen her standing and further diminish the options available for those seeking an alternative Brexit to that proposed by her deal.

This could change if the government wins the Brexit vote scheduled for the week commencing January 14 WITHOUT the support of the DUP. Under such a scenario the DUP have indicated they would then withdraw their support of the government.

Even this remains something of an opaque scenario for the Pound: The currency would benefit if the Brexit deal is passed, but the threat of a Corbyn government would likely put a dampener on any rally.

Consensus forecasts from over 50 of the world's leading financial institutions show upgrades to both the GBP/USD and GBP/EUR exchange rate for 2019. To see where consensus lies, as well as the targets set out by names such as JP Morgan, Natwest, Goldman Sachs and more, please visit Horizon Currency. The GBP/USD forecast document for 2019 is here, the GBP/EUR document here.

4) Retail Woes Signal Economic Slowdown

The plunge in ASOS shares at the start of the week is the latest indicator that the UK economy could be headed for a significant slowdown.

"The Pound traded on a softer footing yesterday on continued Brexit uncertainty and fears of a European slowdown spreading after a series of UK consumer retail stocks suffered significant equity losses," says Lee Hardman, a currency analyst with MUFG.

Asos Plc fell nearly 45% yesterday after it slashed its full-year growth outlook to 15% from a range of 20-25% on a “significant deterioration” in November.

The ASOS warning is interesting in that this company is a pure-play internet retailer and is therefore arguably immune to the entrenched struggles faced by traditional brick-and-mortar retailers, suggesting this is a consumer-led deterioration.

Hardman reflects that earlier this month Sports Direct suffered a 15% drop in a day after CEO Mike Ashley announced that sales had been “unbelievably bad” in November. Similar gloomy outlooks and equity moves have come from Dixons, Primark, Ted Baker, John Lewis, H&M in the past few weeks suggesting a more broad-based weakness in consumer spending during the run-up to the holiday period.

"This raises the spectre of a more pervasive slowdown which amid a still tightening labour market presents a dilemma for the BoE. These are likely yet further signs of a Brexit drag on the domestic economy, with continued house price weakening evident in yesterday’s data and slowing business investment further colouring the near term outlook," says Hardman.

5) Technicals: Euro Looking to Push Higher vs. The Pound

Analyst Karen Jones with Commerzbank says the Euro remains preferred  over the Pound and further gains can be expected going forward.

Jones notes the EUR/GBP last week eased back to the near-term support line, today located at 0.8977; from a GBP/EUR perspective therefore the Pound has recovered to near-term resistance at 1.1140.

"While we would allow for some near term consolidation, the recent move higher does looks directional and we would expect to see the market challenge the .9101 August high," says Jones.

This is suggestive of a fall in GBP/EUR to the August low at 1.0988.

6) Technicals: GBP/USD Could go to 1.22

According to technical analyst Sheba Jafari with Goldman Sachs, "the next level to watch is 1.2573-1.2439. The area includes an ABC target from the September 2018 high, meaning that if it were to hold above the level, there’s a risk this might still be corrective. Ideally looking for confirmation below 1.2439 before engaging in downside exposure, after which the next level in focus is 1.22."

However, longer-term Jafari says it’s difficult to suggest new lows in GBPUSD, mainly because of the impulsive nature of the rally from October 2016 though to April 2018.

"Typically, this should mean that the underlying trend is positive. For that reason, it will be important to watch for signs of a base if/once 1.22 has been reached," says Jafari.

7) Options Markets More Confident Sterling Won't Plunge in January

We are told the cost of insuring against a major slump in the Pound has faded, which suggests either the market is not too concerned by a 'no deal' Brexit happening, or the market is less inclined to believe a 'no deal' Brexit will happen at all.

The UK parliamentary vote on a Brexit withdrawal agreement is now expected in the week commencing January 14th ahead of the January 21 deadline for that vote to be delivered.

"The deal is widely expected to be voted down in its current form, but FX option markets don't seem so concerned with the downside risk to GBP anymore, certainly in the near term," says Richard Pace, a foreign exchange analyst with Thomson Reuters.

Reuters data shows the one-month expiry (January 18) 25 delta risk reversals, which show the implied volatility premium for GBP put (downside) versus GBP call (topside) options, have fallen from mid November highs at 2.5 to trade at 1.0 vol early Tuesday.

In short, the cost of insuring against a big drop in Sterling has become cheaper, largely because demand for protection has fallen.

Pace says longer-dated GBP put premiums have eased, too, although to a lesser extent. "The risk of no deal is deemed to have decreased since the Grieve amendment in early December, giving MPs more say on any final Brexit deal .... If the current withdrawal agreement is voted down as expected in January, then the probability of a second referendum would be likely to increase support for GBP," says the analyst.

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