Analysts Question Pound Sterling's Jump against the Euro and Dollar

Modified: Tuesday, 29 September 2020 07:08 BST

- GBP hits 1-week peak vs. USD, 3-week peak vs. EUR
- Senior EU official says IMB won't stop negotiations
- But FX analysts express caution on GBP rally
- Thursday negotiation briefing set to be key moment of the week

Above: EU Commission Vice President Maros Šefčovič. Photographer: Jennifer Jacquemart. European Union, 2020. Source: EC - Audiovisual Service

GBP/EUR spot: 1.1013 | GBP/USD spot: 1.2854
GBP/EUR bank rates: 1.0805 | GBP/USD bank rates: 1.2594
GBP/EUR specialist rates: 1.0914 | GBP/USD specialist rates: 1.2738
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The British Pound has already this week recovered back above 1.10 against the Euro and above 1.28 against the U.S. Dollar as investors increase expectations for a post-brexit trade deal to be agreed over coming weeks, although progress towards an agreement is unlikely to be smooth which has left numerous foreign exchange analysts questioning the Pound's recent resilience.

While the official messages from officials have been downbeat, unofficial reports out over the course of the past week have pointed to a warmer negotiating environment with both sides firm in their desire to see a deal being reached.

"We are going to proceed with the negotiations. We're going to use every single minute when it comes to the full and proper, timely implementation of the Withdrawal Agreement", said European Commission's Vice President Maros Šefčovič on Monday following a meeting of the committee tasked to implement the Withdrawal Agreement agreed between the two sides in 2019.

"A big percent-plus rally in Sterling boosted the U.K. currency to one-week peaks. If Sterling is anything, it’s volatile. The Pound got a lift from constructive Brexit developments that offered hope of the U.K. and EU reaching a trade agreement and thereby avoiding a messy, no-deal split in the months ahead. Nevertheless, volatile broader markets, coupled with the expectations that Britain’s weak economy could lead the Bank of England to deploy negative interest rates, threaten to undercut sterling rallies," says Joe Manimbo, a foreign exchange analyst at Western Union.

The Pound-to-Euro exchange rate rose above 1.10 following Monday's developments and is seen at 1.1013 at the time of writing on Tuesday, the Pound-to-Dollar exchange rate is meanwhile seen at 1.2854.

Eyes were on Šefčovič as he was the senior EU official who in early September told the UK to drop contentious elements of its Internal Markets Bill (IBM), or face repercussions. The Pound fell sharply on the day Šefčovič made the threat, with some commentators at the time interpreting this to mean the EU would walk away from trade negotiations altogether.

Šefčovič on Monday said he again asked the UK to withdraw the "contentious parts" parts of the IMB by the end of the month. But he also acknowledges the EU's deadline will pass and that "we are willing to work hard with the UK on these issues in the coming days and weeks".

"GBP is likely to be extremely choppy in short term, as UK’s local fears continue to be dominated by rising virus cases and tumultuous trade negotiations in light of the internal markets bill (IMB)," says a foreign exchange briefing note from Citi. "We continue to think a deal remains more likely than not over the coming weeks, but the risk of no-deal is increased."

The UK and EU begin the ninth and final round of trade negotiations in Brussels on Tuesday and are expected to complete the round on Thursday.

The two chief negotiators are then expected to brief the press as to the outcome of the talks, which should prove to be a pivotal moment for the British Pound.

"While we are still several weeks away from a realistic deadline, it is too soon to expect either side to signal a deal is close and GBP is vulnerable negative headlines in the short-term," says Adam Cole, Senior FX Strategist at RBC Capital Markets.

The two sides are unlikely to announce an agreement has been reached, instead they are likely to say a further intensification of talks has been planned, which are known as 'tunnel' talks which see the final and most contentious issues thrashed out ahead of an expected meeting of EU leaders in mid-October.

Any disappointment on Thursday could understandably cause ripples across Sterling exchange rate markets.

"Why markets are suddenly pricing in a greater chance of a deal is not obvious as officials on both sides continue to strike a negative tone on the outlook for the negotiations," says Shaun Osborne, Chief FX Strategist at Scotiabank. "Our baseline firmly remains that the UK will leave the customs bloc on Jan 1 without an agreement."

Irish Taoiseach Micheal Martin said in an interview with the Irish Indepdenent on Monday he is "not optimistic" that a deal will be reached saying that while there was “potential for a deal”, but warned that the government’s controversial legislation which enables the UK to break international law had "eroded trust".

The Internal Market Bill (IMB) was a source of controversy in that it sought to override some elements pertaining to the Irish Protocol contained in the Withdrawal Agreement. The UK Government said this was necessary to ensure there was no chance the EU could effectively ban the export of food from the rest of the UK to Northern Ireland. The EU said the Bill breaks international law and erodes trust.

Martin said the Bill "damaged the credibility" of agreements already entered into.

"I’m not that optimistic, if I’m honest. Just to let you know that the [Irish] government is preparing its budget in three weeks’ time on the basis that there will be a no-deal Brexit," said Martin when asked if he believes a free trade agreement is likely.

"The surge in GBP seems rather dislocated from this mixed messages," says Daragh Maher, Head of Research, Americas at HSBC, citing the Martin comments in a note to clients out on Monday.

Šefčovič requested the UK government to withdraw the offending measures contained in the draft Bill in the shortest time possible "and in any case by the end of the month". If not, "the European Union will not be shy in using" "a number of mechanisms and legal remedies to address violations of the legal obligations contained in the text".

Despite the deadline set down by the EU, they failed to provide any detailed action on what would be done in response to the deadline passing and the UK has proceeded with the Internal Markets Bill.

"It will never be the EU that calls an end to the negotiations on the future partnership," said Šefčovič when asked on Monday what steps would be taken should the UK breach the EU's month-end deadline to withdraw the IMB.

The deadline ultimately looks like it will pass without incident; certainly it has not blunted the EU's desire to get a trade deal secured.

The UK has helped made two small concessions that have helped diffuse tensions over the matter, 1) in agreeing to allow Parliament a final say on whether the actual legislation contained in the IMB that breaks the Withdrawal Agreement is ever executed.

This arguably provides a layer of protection against an over-enthusiastic executive decision.

2) Furthermore, reports out last week suggest the UK has slowed the passage of the IMB through Parliament in order to give negotiations the chance to strike a deal, thereby making the contentious legislation ultimately void.

"While we expect GBP to rebound with the resolution of Brexit uncertainty, enthusiasm over a strong rebound needs to be tempered. Any Brexit transition agreement is likely to be 'skinny’, and the UK is only expected to return to end-2019 GDP levels later than other major economies," says Marvin Barth, a foreign exchange strategist at Barclays.