Pound in the Red but "Should Gain if MPs back PM May's Brexit Deal"

Image © European Union, 2018 / Source: EC - Audiovisual Service

- Pound Sterling under pressure as new year trade kicks off

- Expect appreciation if May's deal passes through parliament

- Options market warn of wild ride for Sterling mid-month

- Pound-to-Euro exchange rate @ 1.1101*

- Pound-to-Dollar exchange rate @ 1.2606**

The British Pound starts the first full trading day of 2019 at a disadvantage against most major currencies, with losses being seen against both the Euro and U.S. Dollar with analysts and money markets alike pointing the blame squarely on the chronic uncertainty surrounding the nature of Brexit the UK will experience in March, if it Brexits at all.

Looking at the performance board, we can see that while the Dollar is enjoying some independent strength owing to a global stock market sell-off, weakness appears to be a Sterling-specific story with foreign exchange options markets showing investors are growing increasingly nervous ahead of the mid-month parliamentary vote on Brexit with traders expecting big moves in the currency around this time.

The cost of buying options that protect against volatility in the currency on two-week and one-month timeframes has risen sharply as investors and businesses fear big moves in the currency around the time of the vote. "Brexit uncertainty is a major negative for GBP," says Robert Howard, an analyst on the Thomson Reuters currency desk.

The UK parliament returns from recess on Monday, January 07 and starts debating the Brexit ahead of a first vote scheduled for the week commencing January 14.

In its current form, the Brexit deal is expected to be rejected, but Prime Minister Theresa May used her New Year's message to urge MPs to back the deal so Britain could "turn a corner," while Downing Street officials have confirmed May has been in touch with fellow European leaders over the Christmas period with the view to securing further concessions that might aid her deal through parliament.

We believe the European Union will give further ground as they know the deal they have worked on for the past two years will be rejected over the clause concerning the Northern Ireland border.

"Sterling could jump if MPs unexpectedly back PM Theresa May's Brexit deal in the Commons vote scheduled for the week beginning January 14," says Howard.

Howard adds that, "if MPs reject the deal but by a relatively narrow margin, the expected Sterling losses could be limited by hope that MPs might subsequently approve the deal on a possible second or even third vote, depending on events."

There was speculation that May's deal would be defeated by around 100 votes on December 11, before the vote was postponed in order to allow May time to eke out further concessions from the European Union to placate opposition.

Paddy Power quotes 6/4 (odds against) for the deal to be approved by the UK parliament before March 30.

In a weekend interview with the Sunday Times, Britain's trade minister Liam Fox said there is a "50-50" chance that Brexit would be stopped if the deal is rejected.

Indeed, further reports over the Christmas break suggest a cross-party cabal of MPs are working on ways to delay Brexit beyond March should the deal be rejected.

Such an outcome, could benefit Sterling to an extent, however we believe it would present an extension to the chronic uncertainty that has been plaguing Sterling for months now.

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It is still not quite clear what options are available to parliamentarians when it comes to thwarting Brexit - and what support these options could command - in the event of May's deal being voted down.

The only obvious route to such an outcome would be for the DUP and Conservative party rebels to back a vote of no confidence in the government when the deal fails. This would set the country on course for another general election.

Again, this invites more uncertainty, and more pain for the Pound.

But the DUP - May's Northern Ireland partners - have indicated they will not vote against the government in the event of her deal failing, they would only vote against the government in the event of the current deal succeeding owing to their opposition to the deal in its current form.

And, we doubt there is a large enough cabal of remain sympathisers in the Conservative parliamentary party to topple their own government. Adam Cole, a foreign exchange strategist with RBC Capital Markets notes that proxy measures (bookies odds and prediction markets) are showing the prospect of the Brexit deadlock being resolved through a second referendum is little changed since mid-December (43% probability and still elevated) as is the prospect of an early election (38% probability for 2019 as a whole).

Hopefully January 2019 will be remembered as the month when the plethora of questions surrounding Brexit were finally answered. We believe only the provision of certainty will benefit the Pound going forward.

"Very little has moved in the Brexit saga over the holiday period. GBP remains in the middle of the narrow range that has held since mid-December. How these probabilities shift - along with that of a no deal exit and of May’s deal passing - will largely determine GBP’s performance into the January 21 deadline," says Cole.

* Note that while the interbank spot rate on the GBP/EUR is at 1.1113 high-street banks are offering rates between 1.08 and 1.09 on international payments. Independent currency specialists are however offering better rates in the region 1.10 and 1.1050.

** The GBP/USD rate on offer at high-street lenders is in the 1.2350 and 1.2440 bracket while independents are offering in the 1.2580 and 1.2630 area.