The British Pound: Is it Now a 'Buy on Dips', Rather than 'Sell on Rallies' Story?

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- GBP reclaims second place among major currencies for 2019.

- After Brexit deal struck in Brussels and 'no deal' Brexit risk fades.

- Tips of more GBP gains stack up as Westminster showdown looms.

- Bank of America says buy GBP dip if parliament rejects Brexit deal.

- Mizuho, SEB and LMAX, among others, all eye more GBP gains.

- But MUFG advocates caution, as Nomura fears can-kicking by MPs. 

The Pound has reclaimed its earlier position as the second best performing major currency of 2019 and could now be becoming, for some at least, a 'buy on dips' prospect rather than the 'sell on rallies' story it's been through much of the year but others are urging a cautious approach toward the British currency.

Pound Sterling has risen against all major currencies this week, enabling it to reclaim the number two spot in the league table of so-called G10 currencies, after Prime Minister Boris Johnson emerged from negotiations in Brussels proclaiming a new Brexit deal.

The proposed agreement is yet to secure the backing of a highly divided and fractious parliament but that's not stopped Sterling from winning back ground that was lost over the summer months as fears of a 'no deal' Brexit rose.  

"My sense is regardless of super Saturday & beyond, whether the deal passes through parliament or not tomorrow, with a 3 month extension, it will pass prior to 31st Jan. The Pound should retain its overall bid tone. Money will flow back into the UK & send GBP higher," says Neil Jones, head of currency sales to financial institutions at Mizuho Bank.

Above: Pound Sterling performance against major rivals this week. Source: Pound Sterling Live.

"There is an upside potential in the GBP from current level no matter what the outcome will be this weekend," says Richard Falkenhall, a strategist at SEB, in a note to clients Friday. "From a trading perspective, buying the GBP/USD is probably a better choice as volatility can be expected to be even higher given that the EUR/USD will react on the outcome as well."

The Pound has performed best against some of the safe-havens that were in such demand among investors until only recently, converting 2019 losses into profits against the Dollar and Yen over the course of the week. But the gains wracked up over more risky rivals like the Norwegian Krone as well as Aussie, New Zealand and Canadian Dollars are also notable. The performance came in, and even contributed to, a truly bad week for the U.S. Dollar. 

Investors, traders and analysts had already grown ever more bullish in their outlooks for the Pound amid claims of progress from London and Brussels but now, and in spite of a parliamentary showdown looming on the horizon, forecasts of more gains were still coming thick and fast on Friday. 

Above: Pound-to-Dollar rate shown at daily intervals.

“While the Pound would be negatively impacted if Parliament goes ahead and votes down this latest deal, we believe the currency will quickly find support on the expectation of ongoing efforts to pursue a solution where the tail risk of disorderly Brexit is averted," says Joel Kruger, a strategist at LMAX Exchange, who now views Sterling as a 'buy on dips', rather than a 'sell on rallies' story.

If Johnson fails to get the approval of enough MPs he will be required by the 'Benn Act' to seek a further delay of the UK's exit no later than the end of Saturday, which will leave the economy mired in even more uncertainty about the future trading relationship with the EU than in the case of any style of exit but would, crucially, avoid a 'no deal' Brexit.

Analysts at UBS say that latter outcome would send the Pound-to-Dollar rate to 1.05 and the Pound-to-Euro rate to 1.00.

Above: Pound-to-Euro rate shown at daily intervals.

There are 650 seats in the House of Commons although one of them is occupied by the Speaker, who does not vote, and seven of them sit unoccupied by the Irish nationalist party Sinn Fein. That reduces the effective majority necessary for passing legislation down to just 322 but the Prime Minister and his Conservative Party have just 288 seats between them, which means he is in need of 34 votes, more than the total number of MPs that have been lost through whip withdrawal and defections.

"Even if the UK Parliament rejects the deal, the election that is likely to follow will have both major parties campaigning for a form of a Brexit deal, which suggests less risks of a no-deal Brexit. Whether the deal itself is good or not is not relevant for GBP for now; it will appreciate sharply if there is any deal," says Athanasios Vamvakidis, European head of FX strategy at Bank of America Merrill Lynch. "We remain positive on the final outcome. We would buy the dip if the parliament rejects the deal."

Bank of America says that a failure by MPs to back the new Brexit proposals on Saturday wouldn't be the end of Johnson's deal. Vamvakidis says the pact could still clear the House of Commons after that stage, likely at the end of January, only that the Pound would first need to sit through an extension of the Article 50 negotiating window as well as a general election that would be necessary in order to reset the parliamentary arithmetic. Many say an election, a prospective third in the last five years, is now inevitable.

Above: Pound-to-Euro rate shown at weekly intervals.

A succesful election campaign that leads the governing Conservative Party to a majority in the House of Commons would then bury the threat of a 'no deal' Brexit at least until the end of the transition period provided for by Johnson's withdrawal agreement. However, it's the strong possibility of the deal being rejected in the Commons and giving way to an election that has led others to advocate a cautious approach toward the Pound from here. 

 "If we’ve got a deal tomorrow then cable could go back to the 1.30-1.35 range," says Fritz Louw, a currency analyst at MUFG. " The momentum is definitely positive but we shouldn’t underestimate the short-term downside – if the deal doesn’t pass in parliament it opens up some questions and this could put a dampener on the recent optimism. There will likely need to be a general election then and that opens up some downside risks. By the sound of it, a lot of people aren’t touching cable at these levels. "

Louw says a proverbial boat has likely been missed by investors and traders who aren't already into profitable bets on a rise in the Pound-to-Dollar rate, which he says might struggle in the absence of parliamentary support for the deal. Financial markets tend to get anxious about elections particularly when economic policies are front and centre in the debates leading up to the ballot.

Above: Pound-to-Dollar rate shown at weekly intervals.

An election will see the Conservatives face off against rivals advocating Brexit pathways that range from cancelling the pursuit altogether, to jumping off a metaphorical 'cliff edge' head-first into a 'no deal' Brexit. It'll also pit proponents of a free market capitalism that's long been on the rocks, against once fringe advocates of a hardcore socialist ideology whose prescription for all of society and the economy's ailments is the open arms of the state.  

A rejection of the deal Saturday could well give way to a push by the government for an election, with all that entails for the Pound, but the rub for the PM in that scenario is that he needs the votes of opposition MPs as well as those ousted from his own party in order to set the ball rolling. And many of them didn't want to leave the EU and for some time, have at least appeared to want to delay and impede, if-not entirely stop, the process.

Former Conservative Party MP Oliver Letwin, who's still an MP in parliament but has been ousted from the party, has tabled an amendment to the motion being debated Saturday that would force Johnson into requesting a delay to Brexit process even if his agreement is approved by the House of Commons. Nomura says this risks parliament kicking the Brexit can down the road without really telling anybody anything new, which might block the path higher for Sterling.

"Expect a lot of noise / action / potential confusion. The biggest risk is that this vote ends up telling us nothing at all," says Jordan Rochester, a strategist at Nomura. "In terms of what this means for GBP…it doesn’t mean GBP downside per say but it increases the risk that we go pretty much nowhere on Monday and stay in this limbo. We remain short EUR/GBP as the downside risks remain limited unless Boris were to not send the letter.

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