Brexit Progress Supports Pound Sterling against Euro and Dollar in a Stormy Market

- GBP resilient on Brexit headlines
- FX markets buffeted by covid-19 developments
- But Brexit breakthrough could be a damp squib warns Saxo

Above: File image of Frost and Barnier © European Union, Source: EC - Audiovisual Service / Photo: Lukasz Kobus

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The British Pound advanced against the Euro and a host of other major currencies on news of progress in post-Brexit trade negotiations, however renewed financial market turbluence following the announcement of new major lockdowns in Europe has pushed the Dollar higher across the board. 

Foreign exchange market participants bid Sterling after a newswire report on Wednesday said negotiators had resolved "some of the biggest disagreements that have long bedevilled the Brexit talks."

The progress is said by sources quoted by Bloomberg to "raise hopes a deal can be reached by early November" and foreign exchange analysts say the Pound will likely remain supported around current levels as long as expectations for a deal remain intact.

Following an intensive round of negotiations held in London it is reported the EU and UK have begun work on the text of an agreement on establishing a level competitive playing field, and are close to finalising a joint document covering state aid.

Bloomberg adds the two sides have also moved closer to deciding essential aspects of how any accord will be enforced.

The Pound rallied against the Euro in the wake of the news and went higher against the majority of its G10 peers.

"Tactically, we see a window of opportunity to take a more constructive view on GBP," says Adam Cole, Chief Currency Strategist at RBC Capital Markets. Cole has made buying the Pound against the Euro his "thematic trade of the week", in anticipation of positive developments concerning Brexit trade negotiations.

"A final conclusion is unlikely this week, but expectations could swing toward exiting with a deal. GBP should also be a beneficiary of month-end hedging flow if equities maintain their month-to-date gains into the end of the week," says Cole.

Above: Sterling outperformed the majority of its peers on a day covid news battered stocks and most other currencies

The Dollar has meanwhile found strong buying interest this week given the substantial safe-haven demand triggered by investors owing to Wednesday's sizeable stock market sell-off linked to  major lockdowns being introduced in Germany and France.

This safe-haven driven demand for the Dollar could coninue over coming days say analysts. "The rush for the exits will continue for the time being. The impressive dive in European markets over the past few days has revealed how dire sentiment is towards this part of the world, with already weak GDP forecasts likely being hastily revised yet lower thanks to the return of lockdown policies," says Chris Beauchamp, Chief Market Analyst at IG.

The developments on Brexit are therefore providing some welcome downside insurance for the Pound which has in the past proven highly sensitive to covid-19 developments: the Pound's lowest point of 2020 against both the Euro and Dollar was reached in the February-March period when markets melted in response to the panic triggered by the first wave of covid-19 infections.

The UK currency therefore remains prone to declines in the event of a second wave, which appears to be transpiring.

Positive Brexit news would in the past have triggered sizeable upside adjustments in Sterling, however gains in the current market environment are likely to prove tepid.

"Our thesis on a Brexit talk breakthrough is increasingly that this may prove a damp squib, given the Covid-19 backdrop and the UK’s external deficits," says John Hardy, Head of FX Strategy at Saxo Bank. Views on Sterling's potential upside in the event of a deal being reached vary, we reported on Wednesday how one analyst sees the potential for the Pound-Euro exchange rate to go as high as 1.25 on such news. 

Upside potential in Sterling is also likely to be limited by the observation that while negotiators have made progress, no mention on the issue of fisheries was made.

As such, expectations that fisheries will be where a final showdown takes place look to be well founded.

The negotiating teams lead by the UK's David Frost and the EU's Michel Barnier will now move to Brussels to continue negotiations.

An obvious risk for those watching Sterling exchange rates is that negative Brexit news - which would most likely be a stalemate on fishing - combines with 'risk off' market conditions to trigger substantial declines in value.

Under such a scenario the Pound-to-Euro exchange rate could rapidly decline towards the 2020 low of 1.0526, while the Pound-to-Dollar exchange rate could be exposed to levels sub-1.20.

Above: GBP/USD remains elevated compared to March lows

Foreign exchange analysts are however unconvinced that the market is about to see a repeat of February-March given the substantial support offered to the economy and financial system by global central banks and governments.

Indeed, the damage of the first wave of covid-19 to financial markets and its subsequent impact on exchange rates appears to have been derived from its shock factor.

"I am not convinced that today’s USD buying will last much beyond noon today as the corporate USD buying fizzles and the market will probably realize that the industries shutting down in Europe were the weak links anyway (restaurants, tourism) and the overall economic impact is not likely to be anything like we saw in March and April. Furthermore, the market can only focus on one major theme at a time and with the election just 6 days away, I can’t foresee COVID remaining the main theme for very long," says Brent Donnelly, a foreign exchange trader at HSBC.