Pound Sterling: Brexit is Back

- EU expects UK to request negotiation extension
- Such an outcome could benefit GBP says analyst
- GBP hit by deteriorating market conditions
- Brexit anxiety lurks in the background

Above: File image of Michel Barnier © European Union , 2018 / Source: EC - Audiovisual Service / Photo: Mauro Bottaro

- Spot Pound to Euro exchange rate: 1.1471
- Bank transfer rates (indicative): 1.1170-1.1250
- FX specialist rates (indicative): 1.1296-1.1368 >> more information

- Spot Pound to Dollar exchange rate: 1.2486
- Bank transfer rates (indicative): 1.2149-1.2236
- FX specialist rates (indicative): 1.2357-1.2375 >> more information

The British Pound has fallen against the Euro, Dollar and a host of other major currencies due to the combination of the sudden return of market weakness linked to the coronavirus crisis and fresh doubts over the ability of the EU and UK to strike a trade deal before year-end as the coronavirus crisis forces both sides to reset their negotiating timeline.

The EU-UK divorce has rightly taken a back seat during the coronacrisis, but there are remain incoming signals that the two sides will fail to reach a new trade agreement by year-end.

"There's hope on both sides of the channel that the Brexit negotiations postponed by the coronavirus can restart next week, but the contentious topic of fishing rights in UK waters could scupper those talks and raise the chance of Britain departing the EU at the end of 2020 with no deal," says Richard Pace, an options market analyst at Thomson Reuters.

"If that likelihood increases, it would clearly hurt the UK economy and GBP, already reeling from the economic impact of the coronavirus," says Pace.

The warning comes as the EU and UK prepare to reconvene talks, which are now far behind schedule and expectations are rising that the UK will inevitably request an extension to the negotiation period.

David Frost, the UK’s Chief Negotiator, and Michel Barnier, the European Commission’s Chief Negotiator, held a meeting via videoconference on Wednesday and given the ongoing coronavirus crisis, agreed three rounds of negotiations would soon take place via videoconference.

The following dates have been agreed for negotiating rounds lasting a full week:

  1. w/c 20 April
  2. w/c 11 May
  3. w/c 1 June

Pace notes the issue of fishing rights appears to be a major stumbling block for negotiators as the EU wants to preserve as many of its existing fishing rights as possible, but Britain maintains that access to its waters should not be connected to talks on trade.

"If there is no progress on this, then there will be no progress in other areas," one EU official told the Financial Times on Tuesday.

Talks stalled over recent weeks owing to the more pressing coronacrisis, with the lead negotiators from both sides having to go into isolation due to the covid-19 virus. Only one of the three formal rounds of negotiations meant to have taken place by now were completed because of the outbreak.

David Frost and Michel Barnier will hold a video conference call to finalise arrangements for large-scale trade negotiations to take place over the internet next week. It is intended that talks would involve up to 11 separate groups of negotiators holding simultaneous talks over video conferencing software on areas from trade in goods and the "level playing field" demanded by the EU, to fishing and law enforcement.

"Brexit uncertainty still hangs over the UK as the deadline to request an extension to the transition period draws nearer, putting more pressure on a UK-EU trade deal to be achieved before year-end 2020," says George Vessey, Currency Analyst at Western Union.

According to The Telegraph, the EU would negotiate an extension to the Brexit transitions period because of the coronavirus pandemic. However, the UK has repeatedly rejected calls for the transition period to be extended owing to the coronacrisis, insisting that a deal could yet be thrashed out in the remaining time.

According to Adam Cole, Chief Currency Strategist at RBC Capital Markets, the UK will ultimately have to come to the realisation that an extension is necessary, with such an outcome likely to prove supportive for Sterling.

"Particularly with PM Johnson in hospital, an extension seems more and more inevitable. To the extent that extending the transition period delays the risk of exiting on WTO terms, in isolation this would probably be positive for GBP," says Cole.

For this reason, RBC Capital Markets have pushed the peak in EUR/GBP into 2021 from 2020, though the peak level remains unchanged (0.96). This gives a GBP/EUR exchange rate low at 1.04, suggesting RBC Capital see significant weakness ahead linked to trade negotiations.

According to the Telegraph report, the expectation in Brussels is that a British extension request must eventually come.

Unless they are extended, the trade negotiations must be finalised by the end of 2020 and no agreement would see the EU and UK default to World Trade Organization trading regulations.

While Brexit anxiety is a thorn in Sterling's side, the primary driver of the Pound's declines through the mid-week period was the deterioration in global investor sentiment that saw a two-week rally in stocks come to an abrupt end as investors were forced to face up to the negative implications of the 'Great Shutdown' by a steady flow of negative economic data and forecasts. The Pound is seen to be a currency that tends to decline when markets are in retreat as is presently the case, and appreciate when the mood amongst investors picks up.

"Is sterling upside capping out?" questions George Vessey, Currency Strategist at Western Union, observing today's sharp slump in Sterling's value against the Dollar, Yen and Swiss Franc and Euro.

Certainly against the so-called safe-havens - of which the Yen, Franc and Dollar are classed - it does appear the recent recovery rally is capping out in line with a broad-based drop in global stock markets and commodity prices.

"Sterling’s valiant recovery has taken a hit... with GBP/USD down over 0.8%, over 100 pips lower than the high of the day. GBP/EUR has also surrendered a lot of yesterday’s gains, highlighting just how precarious these markets are amid these unprecedented times," says Vessey.

The shift in fortunes mark an abrupt about-turn for the investment community that had this week bizarrely priced the world's flagship S&P 500 index at the same level as it was in 2019. To highlight the absurdity of the recent rally, it has been pointed out that if you had bought exposure to the S&P 500 in August 2019, you would have been in profit by April 14 2020.

Market sentiment has over the past two weeks apparently swum against an incoming tide of bad news concerning the global economy, with stock markets rising on a bet that global central banks such as the Federal Reserve had injected enough fresh money into the system to keep markets afloat.

For Sterling, the improved appetite amongst the world's investment community proved beneficial, but this sentiment is now being questioned.

A slew of disappointing earnings data out of the U.S., negative economic survey data for March and a dire forecast from the IMF have all combined to remind markets that there is only so much central banks can do.

"The dismal updated economic forecasts by the IMF paint a bleak picture for the UK, predicting the loss of output next year to be above 5% compared with October 2019 forecasts. The economic impact of the UK lockdown is already being felt, but should the infection rate continue to rise, it will be difficult for the government to ease restrictions, therefore exacerbating the economic problem," says Vessey.

The IMF said that as a result of the pandemic, the global economy is projected to contract by 3% in 2020, which is much worse than during the 2008–09 financial crisis.

The global economy is projected to grow by 5.8% in 2021 as economic activity normalises, helped by policy support.

"The risks for even more severe outcomes, however, are substantial," said the IMF in their World Economic Outlook report for April 2020.

Hammering home the negative sentiment is a renewed decline in oil prices, with the latest IEA report suggesting global oil demand will fall by a whopping 29 million barrels per day in April alone.

With the Pound tightly correlated to global investor sentiment it is little wonder Sterling has sunk lower.

The UK economy has a sizeable financial services sector, with the City of London being a global financial capital. When investors run scared, a huge demand is made on capital which typically sees Sterling-based assets liquidated which in turns puts downward pressure on the Pound.

The British Pound sank in the first half of March as a market meltdown is believed to have seen vast sums of international capital exit the UK as desperate investors and corporates clamoured for cash.

However, the currency recovered through the second-half of March and into April after global central banks stepped in and injected fresh money into the global economy. Of note was the creation of swap lines by the U.S. Federal Reserve with other global central banks to increase dollar funding on March 19, a move that coincided with a recovery in Sterling.

With the latest return to weakness, it appears the high-water mark for the Pound-to-Dollar exchange rate will be the one-month high achieved on Tuesday at 1.2646, while the Pound-to-Euro exchange rate looks to have painted a temporary high at 1.1516.