British Pound Breaking Down against Euro & Dollar in Wake of MiFID Headlines

- GBP down on MiFID headlines
- EU looks to squeeze UK finance industry post-Brexit
- Naive of markets to think otherwise
- However broad USD strength is day's big story

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- Spot rates at time of writing: GBP/EUR: 1.0808, -1.75% | GBP/USD: 1.1852, -2.15%
- Bank transfer rates (indicative): GBP/EUR: 1.0520-1.0596 | GBP/USD: 1.1537-1.1620
- Specialist money transfer rates (indicative): GBP/EUR 1.0650-1.0701 | GBP/USD: 1.1650-1.1745 >> More details

Pound Sterling was seen hitting a new six-week low against the Dollar and eroding the key 1.18 level against the Euro as investors sought to reduce  exposure to the currency ahead of what are expected to be testy negotiations trade negotiations between the UK and EU.

The financial services sector is expected to be a prime target of the EU in upcoming negotiations and reports carried on newswires have suggested the EU are looking to impose tougher financial regulations on the City of London once the UK has exited the Brexit transition phase at year-end

EU sources told the Bloomberg newswire that European financial regulators would look to toughen up an existing set of regulations known as MiFID II which should have a negative impact on one of the UK's main economic sectors.

The UK is a net exporter of financial services to the EU and the move appears to be a clear attempt by the EU to weaken the dominance of the City of London following Brexit.

"The removal could further complicate UK financial firms’ access, or ability, to do business in Europe," says Kim Mundy, a foreign exchange strategist with CBA. "GBP/USD is trading back below 1.3000 as moves continue to be dominated by headlines on UK‑EU trade negotiations."

MiFID was implemented in November 2017 and represented a major shakeup in European financial markets by introducing a series of policies governing research spending, record keeping and trading in stocks, derivatives and commodities. The more stringent policies have been criticised for increasing the difficulty of doing business and imposing significant costs on the financial industry.

The decline in Sterling following the breaking of the news is however most likely not a reaction to news MiFID is to become more stringent, rather it is a reaction to the signal being sent out by the EU: they are willingly going to try and undermine the UK's financial sector in upcoming negotiations.

Therefore, MiFID is probably just the first battle in a more protracted war.

We would however expect the UK to mitigate any negative impacts of the EU's moves, most likely by enacting policies that ensure the UK remains an attractive destination for global finance.

Looking at Sterling markets, we can see the currency showed a clear reaction during the period the newswires broke the story:

The above shows the move of the Pound-to-Dollar exchange rate, alongside the Euro-Dollar exchange rate (orange line). Note however that Dollar strength does seem to be a culprit in GBP/USD's move below the key 1.30 support line.

Below shows the movement in the Pound-to-Euro exchange rate which is probably a clearer indicator of genuine Sterling weakness as it strips out the impact of the broader strengthening of the Dollar.

The weakness at the time of the MiFID news is evident but it does suggest the impact is relatively muted:

"With the week’s main U.K. data releases having come and gone, the pound revisited the bottom of its range as attention shifted back to uncertainty over negotiations for a long-term trade agreement between London and Brussels. Sterling caught a bounce higher this week after upbeat data like services growth, the lifeblood of the U.K. economy, topped forecasts and offered evidence of a nascent, post-election rebound in growth. Yet any positive traction for the economy could be derailed but uncertainty over a trade deal," says Joe Manimbo, a foreign exchange analyst at Western Union.

While MiFID is a factor behind Sterling's move lower, it does appear that the strength of the Dollar might in fact be the bigger story of the day.

Indeed, the market's ability to react to such headlines is again peculiar: the EU is going to attempt to frustrate the UK economy in the post-Brexit era, with financial services being the primary target. We know this and are surprised that the broader market has not priced this.

"Oh look, we have found another justification for smashing the GBP. Pardon me, but I couldn't care less about this MIFID story," says Marc-André Fongern, Head of FX Research at MAF Global Forex.

Regardless, the events of the past 24 hours remind us that the tone of the upcoming trade negotiations will be important for how Sterling trades in 2020 and we expect the currency to remain sensitive to headlines such as those involving MiFID regulations.

"In our view, UK‑EU trade negotiations will be the major driver of GBP volatility this year. However, GBP/USD downside is limited because the cross is significantly undervalued relative to the level implied by real two‑year UK‑US swap spreads," says Mundy.

"A renewed focus on Brexit should keep GBP from making new highs and the level of long GBP positioning encourages us to expect a further fall in the Pound in the short term," says Jordan Rochester, FX Strategist with Nomura International in London.

The EU's Chief trade negotiator Michel Barnier told an audience on Monday that the EU was willing to offer the UK an ambitious free trade agreement in services, with wide sectoral coverage, ranging from business services to telecommunications or environmental services. "We are also looking to include digital trade, intellectual property and access to our respective public procurement markets," said Barnier.

However, the freedom the UK's financial sector will have in the European market will ultimately depend on how much of the EU's own rules and regulations the UK is willing to accept. And here lies the rub: UK Prime Minister Boris Johnson and his Conservative Party are loathe for the UK to be a rule-taker, setting the scene for months of tense trade negotiations.

Lars Henriksson Senior Strategist FX at Handelsbanken says Sterling has been relatively volatile in recent weeks and this should continue, but with a bias to the downside.

"Boris Johnson seems to be hesitant to accept some of the requirements the EU is placing on a free-trade agreement," says Henriksson. "We believe that the GBP will weaken as the problems associated with negotiations with the EU emerge and the end of the transitional period approaches."

However, Handelsbanken thinks that in the end the UK and the EU will most likely agree some sort of a fudge that avoids a disorderly end to the transition period. "This suggests that Sterling will eventually appreciate," says Henriksson.

Dollar Sweeps Aside the Euro and Pound

The strengthening U.S. Dollar is a central theme for foreign exchange markets in 2020 with the currency recording gains against all its major peers:

Above: The U.S. Dollar outperforms its peers in 2020

The U.S. Dollar has been tipped as the preferred safe haven currency during the coronavirus outbreak, largely because the other two major safe havens - the Yen and Swiss Franc - both belong to countries with sizeable trade exposure to China.

Dollar strength is further underpinned by the U.S. economy's ongoing outperformance of global peers.

"Strong U.S. economic data, coronavirus headlines and a further recovery in U.S. equity markets combined to provide USD support," says Mundy.

The U.S. ISM non‑manufacturing index rose to 55.5pts in January (55.1pts expected) while the U.S. ADP employment data showed employment expanded by 291,000 in January, almost double the 157,000 expected.

"The strength in the U.S. labour market is one of the key driving forces of the U.S. economy at the moment. Ongoing robust labour market outcomes will be an important shelter for the U.S. economy from any wider implications from the coronavirus outbreak," says Mundy.

Sterling "retraced against the Dollar as a result of the widespread strengthening of the U.S. currency," says Asmara Jamaleh, Economist at Intesa Sanpaolo, adding that if Friday's labour market report does not disappoint, "the pound could remain on the defensive ... upside will remain limited in any case, due to downside risks stemming from uncertainty over trade negotiations with the EU.

The outlook for the Dollar and GBP/USD could well rest with Friday's labour market report, where analysts are looking for the headline non-farm payrolls report to show the addition of 160K jobs in January, up from 145K in December. A disappointment could allow the GBP/USD to recover the 1.30 handle ahead of the weekend, however a bumper report could only further entrench USD dominance.