Pound Sterling turns Lower Ahead of Key Brexit Vote, but Hints by Germany that Further Negotiations can Take Place is Today's Key Development

Image © Gov.uk.

- 'Zero hour' assistance from EU could yet arrive

- German foreign minister confirms more talks can take place

- GBP trades near multi-week highs ahead of parliamentary vote on Brexit deal

- But beware a "sell the fact" move after tonight's vote

Pound Sterling has reversed earlier multi-week gains and turned sharply lower against its key rivals in the hours leading up to the parliamentary vote on the EU-UK Brexit deal. There is little obvious reason for the move and we suggest that these kinds of moves are typical around big events where nervous traders tend to remove money from the table and drain liquidity from the market.

Currencies can move sharply, and for little obvious reason, when liquidity is thin.

"Under normal circumstances we would say that upside GBP risks outweigh downside ones but FX market illiquidity is preventing us from making that call," says Stephen Gallo, European Head of FX Strategy with BMO Capital Markets. "Due to the liquidity dynamic in the GBP we are loath to assign a 24-48 hour range for GBPUSD."

The government is widely expected to lose the vote, and the loss itself is not necessarily the main concern for Sterling at present. Rather it is what comes next. With this in mind, for us the big story of the day is that Germany has hinted the prospect of further talks are possible after tonight's defeat.

That the EU might be willing to offer any notable concession is a scenario Pound Sterling Live have long believed would be the case, noting the EU's habit of negotiating until the very end. This end point is by no means tonight's first vote on the Brexit deal, rather it is the second vote, we believe.

The Sun's Tom Newton Dunn reported this morning that May "has been given fresh hope of eventual success from a last minute offer of help from Angela Merkel."

The report adds Merkel has, "suggested the EU could grant extra concessions once the troubled agreement is shot down."

This could include persuading Ireland's Taoiseach Leo Varadkar to agree to an end date to the Irish backstop – which the DUP and dozens of Tory MPs have demanded as their price.

Getting the DUP to vote for the deal is absolutely critical for Theresa May as it will significantly undermine the resistance of the most ardent of Brexiteers who see a 'no deal' Brexit as being a preferred outcome to delivering on the spirit of the 2016 EU referendum.

German Foreign Minister Heiko Maas has given credence to the report, today hinting the Withdrawal Agreement could be altered in the event that May’s deal is defeated tonight.

He told reporters outside the European Parliament this morning that:

“The agreement stands, as it is. I doubt very much that the agreement can be fundamentally reopened. If there were a better solution, it would already have been put forward.”

“If it goes wrong tonight, there could be further talks.”

The news is a positive development for the British Pound which is trading towards multi-week highs against both the Euro and U.S. Dollar with markets believing that the success of May's deal is ultimately a positive for Sterling.

Economists believe a deal will unlock withheld investment by UK and foreign businesses and could ultimately set the UK up to be the fastest growing major economy in 2019. "Domestic consumer spending and investment should get a decent boost if and when the Brexit handbrake is released," says Andrew Wishart with Capital Economics.

"The UK has shot to the top of the G7 growth table before on the back of strong consumer spending and investment while the global economy has struggled. If the Brexit cliff edge is finally removed, we think the UK will repeat that performance," adds Wishart.

We saw Sterling spike higher in the past 24 hours on rumours, a move which offered those looking to make international payments a favourable rate of exchange. However, only those who have taken the time to engage a FX specialist will have captured the beneficial move, we recommend readers engage such a service ahead of further volatility.

#GBP overnight volatility rises to highest since general election ahead of #TheresaMay's #Brexit vote tonight. @EburyUK pic.twitter.com/mWYhy1nf8o

— Matthew Ryan (@mryan815) January 15, 2019

Sterling to Benefit on May's Deal Eventually Passing

Pound Sterling is well bid on global foreign exchange markets with investors taking an apparently optimistic stance ahead of tonight's Brexit deal vote in the UK parliament. The Pound-to-Euro exchange rate is trading at 1.1246, the current week high is set at 1.1266.  The Pound-to-Dollar exchange rate is trading at 1.2911, the current week's high is at 1.2928.

Parliament is set to vote on the EU-UK Brexit deal at 19:00, the vote is almost certainly likely to result in a loss for the government and therefore what matters for Sterling is the scale of the loss and the subsequent moves made by parliament and the government. Prime Minister Theresa May last night addressed her backbench MPs in a final attempt to win support for her deal - which includes both the withdrawal agreement on the terms on which the UK leaves the EU and a political declaration for the future relationship.

But many Conservative MPs and the Democratic Unionist Party remain adamantly opposed to the deal and reports suggest about 100 Conservative MPs and the Democratic Unionist Party's 10 MPs could join Labour and the other opposition parties to vote the deal down. The outcome itself is to be expected and those watching Sterling might be disappointed by a lack of fireworks. 

"We do not expect to see an immediate major reaction in GBP following a defeat, given that May’s failure to pass the deal at the first time of asking is widely expected," says Katherin Goretzki, a foreign exchange strategist with UniCredit Bank.

Goretzki says a quick resolution of the uncertainty is unlikely as the different factions in parliament will first seek to exhaust all other possibilities ahead of the 29 March 2019 deadline.

UniCredit's 'base case' remains that either the deal on the table or a slightly amended version of it will eventually pass in the Commons, at the second or third time of asking.

"We expect sterling to rally across the board once it becomes clear that a deal will be found, given the reduction of uncertainty that would result from a deal that allows the UK to avoid the substantial near-term cliff-edge risks," says Goretzki.

Ahead of the vote we see Pound Sterling trading at multi-week highs against both the Euro and U.S. Dollar with a number of analyst telling us this is because traders believe the chance of a 'no deal' Brexit has greatly reduced of late, with Prime Minister Theresa May herself saying yesterday that the odds of a 'no Brexit' are greater than a 'no deal' Brexit owing to the composition of parliament.

May will have three days to come back to parliament and detail her government's next steps. We would expect another vote to be called.

"Parliament wants May to return with a “plan B” solution that would reduce the risk of a hard Brexit. A possible solution is that May tries to postpone Brexit to gain concessions from the EU. However, in order for the EU to accept this, there must be a decent chance that the deal is accepted by the British parliament. Other less likely scenarios include a vote of no confidence and new elections or a new Brexit referendum," says Andreas Johnson, an analyst with SEB.

Reports out yesterday suggest the EU are considering allowing an extension to Article 50 which would push Brexit day beyond March 2019, while reports out last week suggest UK ministers acknoweldge that most alternative scenarios to May's plan require an extension of Article 50. All reports were denied, but we believe where there is smoke there is fire.

Prepare for moves in Sterling and order your ideal exchange rate in advance. Foreign exchange specialists at RationalFX will be working extended trading hours today to deliver advantageous rates to their clients. To get in touch with the team at RationalFX, please see here.

Beware the Rumour Mill

For us the 'wild card' from a currency perspective would be the government losing the vote by a margin of less than 100: with expectations for a heavy +100 defeat being the default, the surprise outcome would therefore be a sub-100 defeat.

Currencies react to surprises, and a loss of less than 100 MPs would immediately signal to markets that this deal has a shot at passing with further amendments. Therefore, we would expect Sterling to extend gains in such an outcome.

However, the base-case scenario we are expecting is for Sterling to end the day lower. Why? Because markets have bid the currency into the vote and we typically find a 'sell the fact' reaction take place when an on-expectation event occurs.

This could well be the case today. Therefore, look for gains to be faded and Sterling to ultimately trade familiar ranges as markets await fresh signs on where the Brexit saga is headed.

Analysts at investment bank TD Securities reckon today's vote outcome "could cast a long shadow over both Sterling and risk appetite in general". The event remains highly binary for the Pound-Euro exchange rate in particular argue analysts, and with only 73 days remaining until the Brexit deadline, TD Securities tell clients they think the path of least resistance for the pair continues to be lower.

However, we and a number of analysts are not of the opinion that weakness will be significant noting that substantial declines are only likely to occur in the event of the chances of a 'no deal' rising substanitally. 

"While a likely defeat is seen as being negative for the pound and the euro, it is worth remembering that with much of the negatively already priced in, it is going to be unlikely that the pound will see the sort of a sell-off (in the worst-case scenario) we witnessed back in June 2016, when the outcome of the EU referendum vote shocked the markets. Indeed, the pound could even stage a surprise rebound even if Mrs May’s deal is defeated, perhaps after an initial drop. So, whatever the outcome of the vote, we think the downside potential for the Pound is limited," says Fawad Razaqzada at Forex.com.

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