Pound Sterling Bats Away Fears of Trade Negotiation Failure to Rally by Over 1% against Euro and Dollar

- GBP up 2.0% against USD this week
- GBP up 1.0% against EUR this week
- Markets still see chance of EU-UK deal on trade
- No breakthrough expected this week

Above: David Frost, Michel Barnier. Photographer: Dati Bendo, © European Union, 2020. Source: EC - Audiovisual Service

• GBP/EUR spot: 1.1233 | GBP/USD spot: 1.2584
• GBP/EUR bank rates: 1.0940 | GBP/USD bank rates: 1.2330
• GBP/EUR specialist rates: 1.1130 | GBP/USD specialist rates: 1.2470
• Find out more about the above

The British Pound retains a bullish tone as markets move through the mid-week trading session with the UK currency holding above the 1.12 and 1.25 levels against the Euro and Dollar respectively.

The gains made by Sterling fly in the face of the pessimism that has built up around the status of the EU-UK trade negotiations, which are this week their fourth and final round before a mid-year assessment by EU leaders.

Markets are expecting both sides to report on Friday that while some areas of negotiations have been settled, significant issues remain outstanding, raising the prospect that the EU and UK default to WTO trade settings in early 2021.

The obvious question is why is the Pound not going lower? In fact, the gains will surprise many who are familiar with the Pound's textbook negative reaction to rising Brexit tensions: The Pound-to-Euro exchange rate has reached 1.1231, having been as low as 1.1085 on Sunday night. The Pound-to-Dollar exchange rate has reached 1.2586, having been as low as 1.2343 on Sunday night.

Above: GBP vs. EUR (blue line) and USD (orange line).

The reason for the Pound's outperformance is twofold: 1) markets have had more than enough time to digest an inevitable lack of progress in these first rounds of trade negotiations and 2) it is clear that there is still a great deal of time and opportunity to seal a deal.

Indeed, a deal will only come about late in the day, as is traditional in such negotiations and therefore it might prove unwise for traders to hit the sell button on the Pound just yet.

It now appears the foreign exchange market's focus will fall on a meeting between Prime Minister Boris Johnson and European Commission President Ursula von der Leyen at some point later this month, where efforts to unblock trade negotiations will be made.

"Sterling could jump in value if a mooted meeting between UK PM Boris Johnson and European Commission President Ursula von der Leyen makes a European Union/UK trade deal more likely by the end of the year," says Robert Howard, a Reuters market analyst.

Howard recalls how the pound soared after an October 10 meeting between Johnson and Irish PM Leo Varadkar opened the door to Britain's EU withdrawal deal, with GBP/USD rising five cents in 24 hours.

UK officials told the Financial Times they hoped Johnson and von der Leyen would inject “political momentum” into talks that have foundered on disputes over fishing rights and EU demands for common standards on state aid, workers’ rights and the environment.

"We need a broad agreement in place by the summer,” one official said. "We can’t still be having this conversation in September or October."

Optimism for at least some progress being made this week was further fuelled by an article in The Times newspaper that the UK is expected to signal compromise on fisheries and “level playing field” trade rules if the European Union backs off from its “maximalist” demands on regulatory alignment and fishing access.

With market sentiment already overwhelmingly expecting this week's talks to end in acrimony - and Sterling reflecting this having fallen throughout the course of May - it stands that the risk of an upside surprise is elevated.

Round 4 of ????????????????negotiations begins today w/ @DavidGHFrost & team.

A crucial week ahead of us to make tangible progress across all areas, in line w/ the Political Declaration. A high-level meeting later this month will take stock of progress.

I will brief the press on Friday.

— Michel Barnier (@MichelBarnier) June 2, 2020

Any progress at all would constitute an upside surprise, and Sterling's rally over recent days suggests a market prepared for such an eventuality,

"We remain cautiously optimistic that the two parties can reach an agreement before year-end, as we expect the negotiations will follow the same pattern as the withdrawal negotiations, where a deal was struck close to the deadline. This is only natural in political negotiations," says Jakob Ekholdt Christensen, Chief Analyst at Danske Bank.

EU Chief Negotiator Michel Barnier told European ambassadors that he believes the UK government wants progress over the next few weeks. David Frost, the prime minister’s negotiator, is keen to counter the perception that negotiations are deadlocked and that a free trade deal with the EU cannot be done this year.

"There is only one way to get things moving and that is for the UK side to move and then, as Frost knows full well, the EU will move too," a senior diplomatic source told the Times. A senior British official meanwhile told the newspaper that unless the government saw tangible signs of progress by the autumn, it would pull out of the talks to concentrate political energies on leaving without a trade deal.

"Brexit negotiations continue, but are hardly going well. Deals tend to be struck last minute, but the risk of a Hard Brexit is non-negligible, as hardliners on both sides may calculate the economic fall-out might as well be wrapped up with the virus damage to the economy. Let’s get it over with, basically," says Jan Lambregts, Head of RaboResearch, Global Economics & Markets at Rabobank.

Trade negotiations will likely remain a slow-burning negative for Sterling over coming weeks, serving to cap any upside enthusiasm. However, as we move into the Autumn, anxieties will likely continue to grow and some substantial downside is likely if talks do ultimately fail.