British Pound "Running on Fumes", Beware Return of Brexit Risks
Above: Theresa May says she is engaging opposition parties to form a consensus on Brexit. Image (C) Pound Sterling Live.
- German justice minister hints EU are eyeing second EU referendum
- EU likely to pivot UK towards softer Brexit by denying concessions on NI backstop
- May knows her government is dead in such an outcome
- Markets guilty of being too optimistic re. Sterling say some analyst
- Pound-to-Euro exchange rate @ 1.1291, Pound-to-Dollar exchange rate @ 1.2860
The British Pound is hovering near multi-month highs against the Euro and U.S. Dollar as markets maintain a wait-and-see approach for further Brexit developments, but we see signs that markets might be overly optimistic on the prospects of a 'no deal' Brexit being avoided.
The currency had been bid higher over the past week with markets betting the defeat of the EU-UK Brexit deal in the House of Commons on Tuesday night actually diminishes the prospects of a 'no deal' Brexit taking place as the UK is forced to delay Brexit and pivot towards a 'softer' version of Brexit. However we see some significant hurdles to these assumptions becoming reality and are hearing from a number of analysts that markets could be guilty of complacency in assuming risks to the British Pound have diminished.
Prime Minister Theresa May won a no-confidence motion in parliament by a 19 MP majority overnight, an outcome that was largely expected by markets and an outcome that is consistent with the ongoing short-term uptrend in the currency that takes it towards the top of recent ranges against the likes of the Euro and U.S. Dollar.
Following the win May said she would immediately open talks with opposition parties in an effort to break the stalemate preventing the EU-UK Brexit deal from passing through the House of Commons.
In an address on the steps of 10 Downing Street at 22:00 GMT May said initial contact had been positive.
"Markets are hoping that these talks might result in a softer Brexit, a delay to it or even another referendum," says Timothy Fox, Head of Research & Chief Economist at Emirates NBD.
Currency market analysts and commentators have attributed the recent gains seen in Sterling to a diminishing prospect of a 'no deal' Brexit taking place on March 29. Reacting to the events of the past 12 hours, investment bank Goldman Sachs have said they believe the prospect of a 'no deal' Brexit has faded further, with analysts at the Wall Street giant saying they believe a variant of the current Brexit deal will ultimately get through the House.
But, in her address to the media outside Downing Street, May did say the leader of the opposition Jeremy Corbyn was refusing to engage in talks which immediately signals to us that no 'grand coalition' on a Brexit deal will be achieved.
Indeed, the view that 'no deal' Brexit risks have faded are not universal and there are a number of analysts who say there is still a strong risk Theresa May's efforts ultimately end in failure. The British Pound is therefore not 'out of the woods' yet and we are wary of a return towards the bottom of its longer-term ranges before the month is out.
Every time Corbyn is criticised for sitting down with unsavoury characters (terrorists, basically) he says you have to talk to people you disagree with...
— Christian May (@ChristianJMay) January 16, 2019
He does not extend that logic to sitting down with the Prime Minister to discuss Brexit
The EU are Gunning for a Softer Brexit, and May Knows She Cannot Offer this
May will present to Parliament on Monday, January 21 her new plan on Brexit; she is expected to announce she will go back to Brussels to seek further changes to the Brexit deal.
"However, the EU is refusing to reopen the Brexit deal, and the question of whether May can persuade opponents in Westminster to support a new deal also has to be questioned following the events of this week. As a consequence markets may be too sanguine about how things will develop from here," says Emirates DNB's Fox.
We are of the opinion that May will go back to Europe to try and secure a legal guarantee that the Northern Ireland backstop, if ever triggered, can only ever be a temporary solution.
This would placate Northern Ireland's DUP party whom May relies on to get legislation through the House of Commons, and it would also draw a large chunk of rebel Conservative MPs towards her cause.
However, we believe the European Union senses that by holding out against changing the backstop they can instead pivot May away from the DUP-Brexiteer cabal towards seeking a compromise with opposition MPs and remain-leaning rebels in the Conservative party who want a softer Brexit.
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German justice minister Katarina Barley has this morning told German broadcaster NDR a second referendum on EU membership "makes sense", a view we believe represents the EU's preferred outcome to the current Brexit stalemate in the UK.
Barley adds that a referendum on Brexit itself, and the Brexit deal would be "two different things".
Furthermore, Barley says the Withdrawal Agreement is not open to renegotiation, a line that has been parroted widely by senior EU officials and leaders since the EU-UK Brexit deal was voted down by the House of Commons on Tuesday.
Also on the airwaves this morning is Germany's Manfred Weber, Leader of the European People's Party in the European Parliament and an ally of Angela Merkel, who says while the EU is open to talking with the UK, they are not open to renegotiations.
It is looking increasingly likely to us that the EU are going to try and push the UK towards a Brexit that is closer to Europe and this will be achieved by blocking any deal that would satisfy the DUP and Conservative party rebels who advocate for a clean Brexit.
But if May abandons this group she risks 1) splitting the Conservative party and 2) losing the support of the DUP, which will bring down the government as the DUP have said they will drop their support for the government in the event of a deal passing that contains the Northern Ireland backstop plan in its current form.
There is therefore a distinct prospect that nil is achieved in Brussels, and for some watching the scene, this spells a 'no deal' Brexit which is after all the only outcome sitting in the UK's statute books come March 29, despite the heavily repeated argument that a majority of MPs would avoid Brexit (still no concrete plan on how this will be achieved).
"We understand that so many domestic and international parties in this process don’t want a 'no deal' scenario, but right now we cannot see a clear path towards preventing one. We would assign the scenario which sees Article-50 extended with a path towards new elections the remaining 55%," says Stephen Gallo at BMO Capital Markets.
And Gallo believes the recent resilience seen in Sterling is nothing remarkable:
"The FX market is not going to force a big move until it is adamantly clear which of the tradeable Brexit permutations is the most likely. The big hedging and investor flow ahead of the current stalemate was done long ago, so participation is low."
We have heard numerous reports that the European Union is willing to talk further on the Brexit deal, and that they expect further clarity to come from the UK. However, the mantra that the Withdrawal Agreement is not open to negotiation is still being repeated and we therefore doubt May's preferred path forward is open to her: the legal assurances required by the DUP can only be secured via opening the Withdrawal Agreement once more.
"I would expect the EU leadership keeps its head firmly buried in the sand and little or no sign of a shift in their position," says John Hardy, chief FX strategist at Saxo Bank.
There is also talk of a delay to Article 50 which would push Brexit day beyond March 29, a move that would go some way in further eliminating a 'no deal' Brexit.
"There is the issue of an Article 50 delay where the complacent assumption is that it will be extended. Something bothers me about the strength of that consensus, but one could also argue that the endgame results in a 'no deal' after all, though a no-deal with a number of bells and whistles to soften the impact, including a long timeline to the implementation of said deal," says Hardy.
Those hoping for a stronger Pound over coming weeks should therefore beware a sting in the tail.
"The GBP may be trading dangerously on fumes and we’d continue place a larger emphasis on the EU’s demeanour and responses instead," says Emmanuel Ng, a strategist with OCBC in Singapore.
May Open to Reopening Negotiations
The Reuters newswire is today reporting that Prime Minister Theresa May is open to the idea of reopening the Brexit Withdrawal Agreement - the legally binding element of the Brexit deal struck with the European Union in November.
This appears to be an admission that the only possible way of getting through the changes she needs to the Brexit deal is by reopening negotiations.
This will require an extension of the Article 50 period and delaying of Brexit beyond March 29. Theresa May's spokesperson has said the government has not yet requested an extension with the EU.
The Labour Party's Jeremy Corbyn has meanwhile said his party could back a second EU referendum.
In a speech in Hastings, Corbyn says "if the government remains intransigent, if support for Labour's alternative is blocked for party advantage and the country is facing the potential disaster of no deal, our duty will then be to look at other options ... including that of a public vote."
