4-5% Gains for Pound Sterling vs. Euro and Dollar on Brexit Delay: ING
Image © Thomas Otto, Adobe Stock
- Delay to Brexit good for Sterling in short-term
- Important to differentiates between long and short delays
- Longer delay of 9-12 months or more best for GBP
Pound Sterling is rising on the back of moves by government to ensure parliament is able to say whether they want to leave the EU without a deal or whether they want an extension to Brexit.
The currency pushed to multi-year highs against the Euro and multi-month highs against the U.S. Dollar on Tuesday after Prime Minister Theresa May told parliament that they would be able to vote on her revised Brexit deal by March 13, and if it is rejected they can then vote on whether or not the UK leaves without a deal. If this is rejected, they can vote on extending the Article 50 process and delay Brexit.
This would presumably give the UK and EU more time to explore alternative solutions to contentious sticking points such as the Irish backstop.
The Pound rose to record a new high at 1.1667 against the Euro and 1.3287 against the U.S. Dollar as markets now see a clear and definite path on which parliament can embark to prevent a 'no deal' Brexit.
Foreign exchange strategist Rai Bipan with CIBC Capital Markets says he attaches a very low probability (0 to 5%) that May's Brexit deal will pass, and almost no chance that a 'no deal' Brexit passes. "We see only a 10-15% chance overall of a hard Brexit," says the analyst in a client note. "As such, investors should prepare for an extension to late-June. This introduces near-term upside risks to GBP on the crosses given how under-hedged GBP bears."
But, when it comes to an extension, we are told the length of the delay could have an important impact on Pound Sterling.
According to analysts at ING Bank, who have conducted an in-depth analysis of two possible deadline extension scenarios, there could be either a short delay of only 2-3 months or a longer delay of 9-12 months or more.
From a currency markets perspective, a delay is good news for Sterling bulls no matter how long it is, but ING suggest a longer delay is preferable to a short delay for the currency.
“GBP rallied to the best levels of the year in January, when the Cooper-Boles amendment held out the prospect of a long delay,” says James Smith and Chris Turner, market strategists at ING bank. “Confirmation of a 9-12 month delay, buying time for alternative policy paths, could trigger 4-5% GBP gains (EUR/GBP to 0.83, GBP/USD to 1.36).”
EUR/GBP at 0.83 gives a Pound-to-Euro exchange rate of 1.2050.
Yet even in the case of a shorter 2-3 month delay, the ING strategists are still bullish the Pound:
“A short delay in Article 50 could generate a temporary 1-2% rally in GBP (e.g. EUR/GBP to 0.85, GBP/USD to 1.33), the return of ‘no-deal’ fears in a few months could see gains quickly evaporate.”
EUR/GBP at 0.85 gives a GBP/EUR exchange rate at 1.1760.
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Politically Palatable?
Any delay to Brexit will have to be approved by the remaining 27 European Union states, and this is where the unknowns lurk. We know from comments made thus far by EU leaders that any delay would need sufficient justification, particularly a lengthy delay and asking for a delay on the basis that May needs more time to renegotiate the existing deal would likely only be granted a few months.
The EU would more likely welcome a longer delay on the basis a second referendum were being conducted or a softer Brexit was being pursued, for instance one in which the UK was seeking to be a member of the customs union.
But the main problem with securing a lengthy delay is that it pitches Brexit into the other side of the European elections in June, which the UK might have to take part in.
On Tuesday, February 26 we have heard the European Union would likely back any decision by Britain to hold a second Brexit referendum and could ease the path by allowing it to nominate MEPs rather than participate in May’s European Parliament elections.
Speaking in Geneva on Tuesday, Jean Asselborn, Luxembourg’s foreign minister, said any such arrangement would need to be short-term and agreed in advance, and that if the UK stayed longer in the EU, the elections would need to be held.
A short-term extension might however be more politically acceptable, but would fail to ease pressure on businesses to the same extent as a longer delay.
"A shorter extension might have short-term political and practical advantages, but it would likely be more damaging for the economy and could easily write off a Bank of England rate hike until much later in the year or beyond,” say Smith and Turner.
Bank of England Would Hike Under a Delay to Brexit
The main factor influencing the Pound at the moment is still the outcome of Brexit, but typically it is Bank of England (BOE) policy and whether or not it is expected to put up interest rates that drives the currency.
Higher interest rates would typically be expected to fuel a rally in the Pound as they would help attract and keep foreign capital inflows.
Rising wages and a tighter economy have led many analysts to predict the BOE could put up interest rates as soon as August 2019, but much depends on the independent variable of Brexit.
In the case of a short delay and then a satisfactory closure in the form of a ‘deal’ the next rate hike might come in November, says ING.
In the case of a short-delay and then another delay (a possible risk with the short-delay tactic because the EU might repeatedly refuse to renegotiate the backstop), no rate hikes might be forthcoming.
But a longer delay of 9-12 months, “may tempt policymakers to hike rates over the summer,” because, “the BoE has signalled it would like to gradually tighten policy further, with the economy operating with little or no spare capacity,” say Smith and Turner.
Hence such an outcome is seen as positive for Sterling from a central bank perspective.
Even in the case of a prolonged delay, there is a risk of no future rate hikes and much depends on whether the economy regains traction in Q2, if not the BOE could delay raising rate rises yet again.
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