HSBC: Pound Sterling's "Balance of Risks" Pointed Higher, see Further Upside vs. Euro and Dollar if Brexit Deal Passes
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- "balance of risks have shifted in favour of further GBP upside"
- Short-term political uncertainty likely to weigh
- Pound-to-Euro exchange rate at 1.1575
- Pound-to-Dollar exchange rate at 1.2827
Despite a week of losses for Pound Sterling, foreign exchange strategists at HSBC say they believe the "balance of risks" facing the currency are now tilted to the upside.
Analysts at the UK's largest high-street lender say a looming Brexit extension reduces the immediate threat of a 'no deal' Brexit, while eventual Parliamentary approval for a Brexit deal would likely see Sterling rally higher.
"Uncertainty prevails as to what the next steps might be," says Daragh Maher, Head of Research and a FX Strategist at HSBC in New York. "However, amid the political wrangling, the balance of risks have shifted in favour of further GBP upside despite its sharp rally over the last two months."
The Pound has been rising steadily against the Euro, U.S. Dollar and other major currencies over recent weeks as markets saw the odds of a 'no deal' Brexit taking place on October 31 diminish.
The rally was given a further boost when Prime Minister Boris Johnson returned from Brussels with a revised deal that showed it could command the majority of the House of Commons when it was put to a vote on Tuesday night.
However, the brakes were applied to the Pound's gains when Parliament subsequently voted against the Government's planned timetable for passing the legislation through Parliament, leading the Prime Minister to pause attempts to pass the legislation.
Johnson said he would now wait on the EU to deliver a decision on delaying Brexit. It is believed Johnson would prefer a short extension, believed to be French President Emmanuel Macron's favoured approach, in order to pressure MPs into backing his deal.
However, it is reported other countries, including Germany favour a longer extension to January 31. A decision could come on Monday.
For Sterling, a long long extension is something of a two-edged sword.
"The threat of 'no deal' has been pushed down the road and is unlikely to suddenly re-emerge as a downside risk for GBP," says Maher. "The main current downside risk to GBP centres on the possibility of a General Election and the associated uncertainty."
Prime Minister Boris Johnson on Thursday said he would ask Parliament to vote for a General Election on Monday, while also agreeing to extend the time required to debate the Brexit deal in Parliament.
Johnson will need to secure a 2/3 majority in Parliament to secure the election, however it looks clear that opposition parties will not agree to the vote.
Government sources have subsequently said they would pull business away from Parliament, thereby guaranteeing a 'zombie' Parliament.
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Uncertainty is rising, and this bodes for short-term weakness in Sterling we believe.
However, HSBC are looking beyond the short-term and say the passing of a deal would aid Sterling suggest the majority of analysts we have heard from.
"There is scope for further GBP upside should Parliament approve a Brexit deal. We have long argued that a deal would likely see GBP/USD gravitate towards 1.40-1.45," says Maher. "The upside risk for GBP in part relies on the idea that should support for a deal be secured in the UK’s parliament, the focus might move back to the economic data. The UK would enter a transition period until the end of 2020, with possible extensions for an additional year or two."
HSBC’s economists note that passing a deal could boost business investment and consumer confidence, while lower inflation from a stronger Pound could help support real incomes.
General Election Poses Problems for the Pound
The prospect of a General Election will however likely keep the Pound under pressure, as the electorate could throw up some market-unfriendly results.
One 'unfriendly' result for Pound Sterling would be another hung parliament where no one party holds a majority. The risk with such an outcome is that the UK faces another period of deadlock in Parliament, ensuring no sustainable resolution to Brexit is agreed.
Another market-unfriendly outcome would be a Jeremy Corbyn-lead government, with Nigel Green, CEO of the de Vere Group saying: "Labour leader and leftist firebrand Jeremy Corbyn might become the UK’s next Prime Minister. His anti-business, low-profit, high-tax policies - including a possible wealth tax - can be expected to spook the financial markets, damage long-term sustainable growth of the British economy, put more pressure on UK financial assets, and lead to a significant sell-off of the Pound."
Polls do however point to a Conservative majority shaping up, with the party growing its lead over Labour and the Brexit Party since Johnson replaced Theresa May as Prime Minister.
"Unless the polls swing aggressively towards the Brexit Party or Labour at the expense of the Conservatives, election uncertainty weighing on UK risk should be bought into if you, as we do, believe the election base case is a Conservative majority. We still like buying dips," says Adam Pickett, at Strategist with CitiFX on his approach to Sterling going forward.
Neil Jones, Head of FX Sales, Financial Institutions, at Mizuho Bank in London says he sees an election coming, and that under a worst case scenario a Brexit extension lasts up to January 31. However, the outcome of the election is expected to "generate Sterling demand," says Jones, and this "all favours higher, longer-term Sterling into 2020."
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