Pound Sterling: Brexit Rhetoric Reaches "Fever Pitch", Potential Dec. Losses against Euro and Dollar Possible says Analyst

Modified: Tuesday, 01 December 2020 07:18 GMT

- Merkel speaks on trade negotiations
- GBP faces downside risks in Dec.
- Brexit deal still represents a trade shock for UK says Deutsche Bank

Above: Angela Merkel, file image © European Union

Market rates: GBP/EUR: 1.1176 | GBP/USD: 1.3362
Bank transfer rates: 1.0960 | 1.3090
Specialist transfer rates: 1.1075 | 1.3250
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The British Pound firmed at the start of December amidst signs trade negotiators continued to inch towards agreeing a post-Brexit trade deal, aided by positive comments by Germany's Angela Merkel.

Sterling rose against the Euro and Dollar on November 30, cementing a solid end to what has been a broadly good month for the UK currency on comments made by Merkel urging negotiators to "put all of our efforts into the last step".

The gains meant the Pound-to-Dollar exchange rate rose 3.0% in November, but it appears that the majority of this move was down to U.S. Dollar weakness than runaway Sterling strength. Indeed, the Pound-to-Euro exchange rate - the bellwether exchange rate for Brexit sentiment - had only managed to rise 0.43% in November, adding to the 0.80% gain of October.

While the gains are not meteoric they nevertheless betray an underlying assumption in the market that a deal will be achieved, although some analysts warn of the potential for a decline on any disappointing news.

"After the gains of recent weeks sterling also look vulnerable to a downward move as the Brexit process heats up once again. The rhetoric from both sides is reaching fever pitch, since despite all protestations to the contrary real progress on fish and the level playing field appears to be lacking. Like equities, sterling has been fairly immune to bad news of late, but after a huge rally, not just since September but since the middle of the year as well, it will need some really good news to avoid a fall into December as the reality of a no deal Brexit begins to take shape," says Chris Beauchamp, Chief Market Analyst at IG.

The market is currently trading on unofficial news whereby government sources and members of the various negotiation teams brief members of the press off the record.

This means the Pound can move on rumours which are ultimately denied, creating a febrile atmosphere where volatility is high but directional progress is slow as investors see little benefit in taking a major directional bet on a currency where visibility is so low.

"Sterling is consolidating around 1.3350 for a seventh day, as the market awaits the outcome of Brexit negotiations. The only certainty is that volatility is coming – with a growing risk that ties between the UK and European Union will remain strained even after any 11th-hour agreement," says Andrew Spencer, a Reuters market analyst..

Above: Pound-Dollar weekly chart, showing the market is in an area of strong technical resistance

The overall assumption is however one that a deal will be done, even if conviction can waver.

"My UK government sources (multiple) say they can see a political solution to the impasse in EU free trade talks that relates to level playing field conditions, state aid and enforcement conditions, but that the EU offer on fishing rights in UK waters is wholly unacceptable," reported ITV's Political Editor Robert Peston on Monday. "By contrast, Brussels sources say the precise and diametric opposite, that fishing looks sortable whereas the gap on level playing field/state aid/enforcement is still yawning. Although confusing, this probably reflects the differing priorities on each side, and paradoxically it is grounds for optimism that a compromise is within reach."

The Peston report was said by one trader we follow to have been one potential trigger behind the Pound's firm end to November.

German Chancellor Angela Merkel added to a guarded sense of optimism when she said on Monday that she hopes for a positive conclusion to negotiations, and that some EU states "are becoming a little impatient".

She said the concern by some member states was that the time within which to secure a deal was running down.

But she said securing a deal will require a "deft hand".

"Markets still expect a deal, and German Chancellor Angela Merkel remains positive .... No deal would be bad news for both the European Union and UK economies as they wrestle with the coronavirus. Hence nobody at the negotiating table wants to be the first to walk away," says Spencer.

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Merkel repeated the old mantra often used by both sides that "we don't want an agreement at any price."

Merkel added that the UK and EU "share the same values" and "it'd be a rather poor example for the rest of the world if we couldn't obtain an agreement". She urged the EU to "put all of our efforts into the last step".

The Pound is widely expected by analysts to rally in the event that a deal is reached, however it is notable that the majority of analysts we follow warn that upside will be limited.

There is concern that while a deal does unlock some upside potential the headwinds of the new post-Brexit trading relationship will be notable.

"Expectations that a trade deal with the EU can prevent a no-deal Brexit are flying high. Nevertheless, euphoria in case of a deal could sober up to realism, because a basic free-trade deal only remains a hard Brexit. Therefore, we stick to a Neutral long-term GBP outlook and do not expect the pound to join European currency strength," says David Alexander Meier, an economist at Swiss private bank Julius Baer.

Analysis from Deutsche Bank shows that a Brexit trade shock could knock off at least 0.6pp from annual GDP, even with a deal.

"The UK will face its worst trade shock in history via Brexit on 1 January 2021," says Sanjay Raja, Economist at Deutsche Bank.

Deutsche Bank say the combination of scarring effects from the pandemic as well as Brexit will act as a material drag to the medium-term outlook.

"We continue to expect the UK's recovery to be a protracted one, with output only returning to its pre-pandemic levels around 2024," says Raja.

"Put simply, with the UK leaving the single market and customs union, importers and exporters will face tariffs (in a no-deal scenario) and non-tariff barriers (in both a deal and a no-deal Brexit). This should increase the cost of trade with the EU," says Raja.

The analyst says that for Brexit to be a success, the UK will need to look both inward and outward, ramping up structural reform via fiscal policy to deliver on its productivity targets while striking new trade deals to claw back some of the reduction in trade capacity.