British Pound Overvalued by Optimistic Markets Ahead of Key Week in British Politics, Warnings of Short-Term Downside Risks vs. Euro and Dollar

Above: File photograph of Jane Foley, Rabobank. Image © Pound Sterling Live, Still Courtesy of Bloomberg News

Pound Sterling came under heavy selling pressure on Friday, with traders cutting back on exposure to the currency ahead of what promises to be a critical week in British politics. The Pound-to-Euro exchange rate went nearly 1% lower to trade below the psychologically significant 1.16 level to close at 1.1581. The Pound-to-Dollar exchange rate went half a percent lower to close at 1.3017, its lowest level since mid-February.

The more cautious approach to Sterling is warranted says Jane Foley, senior FX strategist at Rabobank, who says the market might have been too optimistic on Sterling over recent weeks.

“I think the market has a bias towards pricing in a soft-deal,” says Foley, “If we look back in 2016 and referendum Sterling was then positioned for a remain vote. Clearly, we didn’t get that, and Sterling plummeted. If you look at the consensus put out by most banks and forecasters, really for months, it has been that we will get that soft-deal, we will get a trade deal after that. Again, if we look at Sterling’s performance this year, it is the best performing G10, it certainly was last week. The market has a tendency to look on the bright side.”

The call comes ahead of a critical week in British politics.

MPs are due to vote on Prime Minister Theresa May's Brexit deal next week; if the deal fails they will then vote on whether or not the UK should request an extension to Brexit from the EU. Sterling has outperformed its rivals in 2019 as markets have priced out a 'no deal' Brexit over recent weeks noting there is no great appetite for such an outcome amongst MPs who are expected to back a delay.

Foley warns despite the view an extension is looming, there remains a risk of a 'no deal' Brexit after any delay is announced, and if this were to transpire the Pound would fall steeply since the market is not positioned for such an outcome.

“The fact of the matter is, that legally, that is currently the route we are positioned on. We are facing a hard-Brexit unless some sort of change in law goes through, really, quite soon. So next week it is going to be really, really, key," says Foley.

"The market has a tendency to celebrate delay, and it bought Sterling on the back of the assumption that there will be a delay,” adds Foley. “But as Theresa May has pointed out, a delay could be till the end of June, and a hard-Brexit or a cliff edge could be all the more steeper then. A hard-Brexit is still a scenario that is feasible, and the market will have to judge over the next few weeks or the next week whether that is a scenario which needs to be more priced in.”

The prospect of Prime Minister Theresa May succeeding in getting her deal across the line has deteriorated over recent days with signals coming out of Brussels that EU and UK negotiators have failed to reach a compromised position on the Northern Ireland backstop.

Attorney General Geoffrey Cox and Brexit Secretary came back from negotiations held in Brussels on Tuesday with no progress to report; indeed accounts of the talks were they "did not go well."

Without material concessions from Brussels there is little reason for Conservative party opponents of the Brexit deal to fall behind their Prime Minister.

Nor are attempts to woo Labour Party votes showing any promise: recent concessions from the government in the area of protecting workers rights and extra money for poorer regions - designed as a sop to Labour MPs to win their support - likely to succeed: unions and members of the opposition have already criticised them as being inadequate.

“As is stands press reports citing parliamentarians are indicating that May’s deal is unlikely to muster the required support to push it through parliament next week. In order to attract the support of Labour MPs May has outlined a package on workers’ rights. However, this has been criticised by trade unions and Labour officials as “deeply disappointing”. Additionally, May has promised a fund of £1.6BN to support poorer towns in the UK, but some commentators have dubbed this a bribe,” says Foley.

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Pound Bulls Will be Hoping for a Longer Delay

With a delay the most likely outcome from next week’s Brexit end-game positioning, the next question may be, how long will the delay be?

Rumours out last week suggest the EU are considering offering a two-year delay, news that saw the Pound jump, which tells us the currency would prefer a longer delay.

John Hardy, head of FX strategy at Saxobank, says markets are not being optimistic enough, especially not about the chances of a complete exit from Brexit and a second referendum.

“I think this no-deal scenario should be priced out a bit more thoroughly,” says Hardy in an interview with Bloomberg News.

“If we don’t get this soft-deal passed next week we could be looking at a more significant delay, and then eventually a second referendum. I know it is priced in at very lows odds but I would keep it out there. After all, the soft-Brexit deal neither satisfies the remainers, who want to completely remain in the former status quo, nor does it satisfy those in favour of Brexit who would actually prefer a no-deal and more sovereignty for the UK, so I think maybe the odds are a little bit too in favour of this soft-Brexit panning out,” says Hardy.

Consensus Still Favours a Deal

Markets continue to hold a consensus view that a deal will ultimately be passed, and it appears to us that expectations for a third vote are 'on the money' with regard to this.

The Rabobank view is that the UK will avoid a hard Brexit and Sterling will continue to rally as a result.

“Despite the clear risks, it remains our central view that an orderly Brexit will eventually be achieved,” says Foley, “On this scenario we would expect EUR/GBP to settle in the 0.85 to 0.86 area in the coming months. On a 12mth view we see EUR/GBP around 0.84 and cable pushing towards 1.37. On a hard Brexit, we would expect EUR/GBP to spike up towards parity which cable plunging towards the 1.13 area.”

EUR/GBP at 0.85-0.86 gives a Pound-to-Euro exchange rate at 1.1765-1.1630. 0.84 translates into 1.19.

Time to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.

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