Pound Sterling Recovers, but Fisheries Showdown Looms Large

- UK won't walk away from talks, govt. confirms
- EU leaders set up showdown over fisheries
- Traders await key EU summit
- GBP expected to be volatile intraday

Above: File image of Michel Barnier, Simon Coveney, Photographer: Aurore Martignoni, Copyright: European Union, 2020. Source: EC - Audiovisual Service.

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The British Pound has recovered ground lost against a host of major currencies earlier in the week on fresh news headlines confirming the UK won't walk away from trade negotiations as their self-imposed deadline races into view.

The government confirmed on Wednesday they would stay at the negotiating table, relieving concerns that talks would break down due to a lack of progress.

The move confirms the government believes progress has been made and that a deal is likely, an outcome that is seen by markets to be positive for Sterling exchange rates.

"Sentiment is building in the market the UK may not terminate negotiations this week with the EU. The Pound is outperforming across the board this morning & holding in well, on elevated chances talks will continue beyond mid October," says Neil Jones head of FX Sales for financial institutions at Mizuho Bank in London.

However, some traders have expressed surprise at the market's reaction as there were few political commentators or market analysts who seriously believed the UK would crash negotiations this week and a deadline of late-November or even early December always looked more realistic.

At the very least, the move in Sterling should serve as a reminder that intra day volatility is likely to be elevated over coming days, if not weeks as automated trading algorithims primed to react to news headlines go to work.

The Pound fell against the majority of its peers heading into Wednesday in an environment of broad Dollar strength and heightened volatility ahead of a summit of EU leaders on Thursday and Friday where it is expected more clarity on the Brexit outlook will be provided.

The Pound is likely to remain highly reactive to headlines concerning negotiations as a result of the intensification of political wrangling, but it is not expected to enter a protracted directional move until there is clearer guidance as to whether a deal is likely or not.

Boris Johnson, European Commission President Ursula von der Leyen and European Council President Charles Michel are to hold conference call on Brexit today with a view of trying to make some progress on Brexit trade negotiations ahead of the key meeting of EU leaders.

EU leaders are due to meet on Thursday and Friday at an European Council summit where trade negotiations are on the agenda, and leaders will be asked to agree on what a final deal might look like and consider what concessions they can make to the UK in order to secure a deal before the year-end deadline for the transition period.

The meeting comes amidst an ongoing deadlock on the issue of Level Playing Field Provisions (state aid), the future governance of a deal and fisheries, with the latter likely to be the most difficult political issue to overcome.

"The Pound continues to derive support in the near-term from building optimism that the EU and UK are moving closer to a Brexit trade agreement. The upcoming EU Leaders Summit on 15th and 16th October will provide an important test of whether the GBP’s recent upward momentum can be sustained," says Lee Hardman, Currency Analyst at MUFG.

Above: GBP/EUR has been trending higher of late. If you have any international payment requirements and would like to secure today's rate for use in the future, thereby protecting your budget, please learn about the options available to you here.

Hardman says gauges of implied volatility around the event has picked up modestly, "but is not particularly elevated suggesting that market participants are not overly concerned over the risk of a sharp GBP move." This finding would be consistent with a market that is well prepared for negotiations to extend into the coming weeks.

Fisheries is looking to be a final showdown in talks as a number of EU coastal states are pushing for their access to UK waters to remain unchanged. However, negotiations over fisheries might not be a simple conversation between the EU and UK as other EU states with no exposure to UK fisheries will be expecting some concessions from their side in order to ensure trade with the EU's second-largest export market is not damaged by a 'no deal' outcome.

After all, fisheries makes up less than 1.0% of the EU economy.

"There's been some progress on Level Playing Field. There's been little to no progress unfortunately on fishing, and both sides are still far apart. EU fishermen are not going to be sold out... to get an agreement on a future relationship with the UK on trade," said Irish foreign minister Simon Coveney on Tuesday.

Ireland joins Spain and France in seeking to ensure the EU has as much access to UK fishing waters as they currently do. France is proving particularly adamant that it must retain the same levels of access to UK waters for its fishermen as part of any Brexit deal.

However, the UK argues that as an independent coastal state it should take back full control of its waters.

One prominent reporter we follow, owing to his strong track record on reporting on Brexit negotiations over the past four years, says that it could be a good omen for a deal that talks are now stuck over the issue of fisheries.

"When both sides start singling out fisheries as the main obstacle then we're almost there. The expectation has always been that it'll be left to last for leaders, to provide their deal-clinching moment in the sun. Ultimately to the EU it's less important than LPF and governance," says Nick Gutteridge, freelance Brussels reporter, currently contributing to The Sun.

Ahead of the EU Council meeting the Pound-to-Euro exchange rate - which is the litmus test for GBP's Brexit sensitivities - trades at 1.1000, having touched its highest level since September 08 on Tuesday at 1.1087. The Pound-to-Dollar exchange rate meanwhile trades at 1.2915, having gone back below 1.30 over the course of the past 24 hours courtesy of a broad-based Dollar rally.

"We retain our cautiously optimistic view on GBP and think that a 'skinny' trade deal is more likely than no deal. Such an agreement, however, may only come after this week’s EU Summit, leaving scope for less-than-expected event volatility this week. In any case, we think that Sterling is likely to remain headline driven but that downside is likely to be capped because of its undervaluation," says Nikolaos Sgouropoulos, a foreign exchange strategist at Barclays.

A comment from German Chancellor Angela Merkel out on Tuesday provided an ever-so-slight nudge to those EU nations such as Ireland that would stand in the way of a deal over their hard stance on fisheries:

"We won't let Ireland down but will continue to stick together in these exit negotiations... but we have to bear in mind the realities because an agreement has to be in the interests of both sides, in the British interest and in the interest of the EU’s 27 member states.”

Germany's Europe Minister extended the request for compromises from fellow EU states; when asked by Gutteridge if the EU's status quo fisheries position is realistic, his reply was "in a compromise we have to move towards each other's position."

Despite his tough rhetoric on fisheries, Ireland's Coveney said he thinks a deal "is very much still possible. But there’s an awful lot of work to do for the two negotiating teams."

"The negotiations have narrowed to a relatively small set of issues (primarily state aid and fisheries), and we still expect that political agreement will be nudged along by the upcoming EU Council summit on 15-16 October. While the medium-term outlook for Sterling remains uncertain — the country must find a way to finance its current account deficit under a new trading relationship with the EU — a negotiated deal would remove significant tail risks for the currency," says Zach Pandl, an economist at Goldman Sachs.

Natwest Markets says Brexit uncertainty should however remain a feature for weeks to come as the EU sees benefit in letting the clock run down on negotiations, allowing them to extract further concessions from the UK.

The Pound tends to underperform at times of heightened Brexit uncertainties and therefore suggestions uncertainty could run until early December opens the door to potential downside.

"The EU’s need to compromise is less pressing given the impact on the UK under no- deal will be greater, so there’s potential value in running down the clock to apply additional pressure on the UK," says Paul Robson, Head of G10 FX Strategy EMEA at Natwest Markets in London.

Natwest Markets expect negotiations to "run to the wire" and see a deal coming in late November or even early December.