Pound Eyes May's Meetings with Macron & Merkel Ahead of Brexit Summit Summit

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- May faces uphill battle when she meets France's Macron on Tuesday

- May/Corbyn said to be in perfect 'prisoners dilemma'

- Pound-to-Euro exchange rate @ 1.1580

- Pound-to-Dollar exchange rate @ 1.3048

UK Prime Minister Theresa May will in the next 24 hours fly out and fight for European leaders to grant her wish of a Brexit delay to June 30, with meetings with French and German leaders due to take place ahead of Wednesday's crunch EU summit.

EU leaders are set to discuss how long a Brexit extension should be with opinions ranging from as little as two weeks to a year.

We believe the decision on the matter could spark potential fireworks in Sterling.

If the European Council grants either May's June delay or Tusk's so-called 'flextension', we would expect Sterling to be supported as it ensures the UK will avoid a 'no deal' Brexit come Friday, the day the UK is officially supposed to exit the EU.

The Pound was supported ahead of the weekend on reports European Council President Donald Tusk will this week propose to European leaders they offer the UK a 12-month "flexible" Brexit delay that allows the UK to Brexit as soon as a deal is finally ratified by parliament.

On Monday it was announced May is to fly to Germany and France on Tuesday in a bid to persuade EU the leaders of the EU's two most influential states to agree to her request.

It is the meeting with France's Emmanuel Macron that we believe will be critical.

Reports have been circulating that France, Belgium and Spain see too much danger to the EU's integrity in offering a long extension to the UK, and the three countries are reportedly keen to only offer a short, two week extension that would allow both sides to prepare for a 'no deal'.

A diplomatic cable seen by the Guardian reveals France's ambassador secured the support of Spanish and Belgian colleagues in arguing that there should only be, at most, a short article 50 extension to avoid an instant financial crisis, saying: “we could probably extend for a couple of weeks to prepare ourselves in the markets.”

We believe this to be a significantly negative development as it implies some in Europe are ready to move forward and put Brexit behind them, and the chance of a 'no deal' Brexit is therefore more substantial than reflected in the current sanguine behaviour of the British Pound.

We are wary that markets might start to increasingly focus on the matter and a sell-off in the value of the Pound would be the most obvious expression of this realisation.

Remember, all 27 EU states have to sign off on whatever deal is offered to the UK and the extent of the apparent opposition amongst 'core' EU members cannot be ignored.

Germany is however reportedly open to Tusk's offer of a flexible extension as they are said to be eager to avoid a 'no deal' at all costs.

We feel that if France, Belgium and Spain win out, the UK parliament will face a crunch vote on Thursday that provides MPs a final chance to approve a deal or leave without one the following day.

The opportunity for parliament to vote for another delay to Brexit will no longer be possible as the decision lies exclusively with the remaining EU states: time will have finally run out and parliament will finally have to vote for May's deal, or back a 'no deal' by rejecting it.

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A Cross-Party Saviour for Sterling

Much will of course depend on whether Labour and the Conservatives strike a deal that both parties can support in the House of Commons ahead of Wednesday's EU summit, if they do, and a deal is voted through at some point this week, then we would expect a sharp rally in Sterling.

"Watch for more definitive steps towards a compromise ahead of the EU Council meeting," says Zach Pandl, a foreign exchange strategist with Goldman Sachs. "We continue to see substantial upside for GBP on a 'soft' Brexit resolution."

As of the time of writing, the two sides have not even met, with a spokesperson for May saying she is hopeful that the government would resume formal talks with Labour on Monday to try to find a solution to the Brexit impasse.

The spokeswoman adds the prime minister wants the United Kingdom to have an independent trading policy and both sides will need to compromise in the talks.

And therein lies the problem: May wants an independent trade policy, Labour would happily sacrifice that for a tighter trading relationship with Europe.

Discussions stalled last week with the Labour claiming that May failed to offer "real change or compromise" in talks.

The Labour Party are advocates of the UK joining a customs union with the EU in the future to ensure trading relations remain as fluid as possible.

Labour's Brexit negotiator Sir Kier Starmer says "exchanges of communication" had taken place over the weekend and, while no talks were scheduled for Monday, he said things could develop.

He said an agenda had been circulated that included the idea of a confirmatory referendum.

"Both us and the government have approached this in the spirit of trying to find a way forward. We haven't found that yet. We will continue to do that," said Starmer according to Reuters.

"The ball is the government's court... we need to see what they come back with and, when they do, we will take a collective position on that," says Starmer.

 

The Prisoners Dilemma

However, a customs union would leave the UK unable to strike its own independent trade deals, an outcome unpalatable to members of the Conservative party who stood on a manifesto to deliver just that at the 2017 general election.

"From a game-theoretical viewpoint it is still more than difficult to imagine a solution that untangles the Gordian knot. Jeremy Corbyn needs to have a different view from that of Theresa May, if he wants to conquer Downing Street after the next election, while Theresa May needs a solution that keeps DUP (and most Conservatives) happy, otherwise the government is dead. For May this implies leaving EU without a backstop, but with a deal," says Martin Enlund, a foreign exchange strategist with Nordea Markets.

Enlund suggests the leaders of the UK's two largest parties are caught in a perfect prisoner's dilemma: the incentive for either to pursue the common good is absent. Can 'prisoners' May and Corbyn extricate themselves from their dilemma and sustain cooperation when each has a powerful incentive to appeal to their party bases?

"British politicians had more than enough time," says Ulrich Leuchtmann, an analyst with Commerzbank, "it is impossible to take a decision without time pressure. From a game theory point of view an extension is even counterproductive."

Enlund agrees, saying that extending Brexit will almost certainly only extend the impasse and delay much-needed decisions, and therefore any long Brexit being offered by the EU is not necessarily a positive for Sterling's outlook.

"We don’t consider a potential long prolongation of the deadline a GBP positive scenario, as nothing will happen in the meanwhile. Low visibility, no investments and poor key figures – you name it," says Enlund.

Up until now we have observed foreign exchange markets to hold a long Brexit extensions as good for Sterling as it further nullifies the prospect of a 'no deal' Brexit.

We warn readers that we could see a shift away from this thinking into the view that a long delay is in fact bad for Sterling, or at least unhelpful.

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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