May's Speech Won't Help Pound Sterling: Analysts

The outlook for the British Pound rests almost exclusively on what Theresa May says in her first major set-piece on upcoming Brexit negotiations on Tuesday January 17.

The Pound has suffered another bumpy ride this week, as concerns about the economic impact of a
hard-Brexit have lingered.

Sterling began the week on a shaky footing, following a Sky News interview in which Theresa May strongly implied that the UK would cease to be a member of the Single Market after it leaves the EU.

The Pound’s decline was only halted following Donald Trump’s poorly-received press conference which, emphasised the fact that markets appear to have previously focused more on the “good” elements of Trump’s plan, such as the fiscal stimulus, rather than some of the “bad” bits such as trade wars and the building of a wall between Mexico and the United States.

The rally proved short-lived as the Pound pared gains on the announcement that May would be delivering her speech on Tuesday January 17.

May is expected to reveal details regarding her Brexit strategy and according to a spokeswoman, she will be, “setting out more on the negotiating approach to Brexit as part of preparing for the negotiations and continuing to be an outward-looking nation.”

From a Pound Sterling perspective, markets will be looking for clarity on how important single market membership will be.

At present we note that markets are pricing some kind of exit from the single market.

"The government has sent clear signals that the UK will leave the single market, but is ambiguous about whether to remain in the EU customs union or leave and negotiate a free trade agreement (FTA) with the EU," says Sarah Hewin at Standard Chartered.

The biggest risk to business is a disorderly Brexit: The UK walks away from negotiations, gives up on the transition and falls back on WTO rules to govern trade with the EU.

Those that think that a hard-Brexit is now fully absorbed into the price of the Pound need to think again.

HSBC warn of the prospect of a “diamond-hard Brexit: WTO trade rules, complete control over movement of people, and no more contributions to the EU budget.”

The GBP/USD will fall to 1.10 under this scenario say HSBC.

What will be important to markets is the Government's latest thinking with regards to an interim deal that would avoid what Theresa May herself termed a cliff-edge.

The EU is unlikely to start negotiations on a post-Brexit trade agreement before the UK leaves the EU (target date: Q2-2019), and an FTA may not come into force until four to six years after Brexit.

If the UK decides to leave the customs union, a transition agreement will be needed between 2019 and the start of the EU FTA in 2023-25.

"The opportunity for the UK to set its own trade arrangements was a centrepiece of the Brexit campaign, and there is pressure from Conservative eurosceptics for the UK to leave the customs union," says Hewin.

This Speech will not Help the Pound

Analyst Paul Hollingsworth at Capital Economics is doubtful that we will gain much new information from Mrs. May’s speech.

"It has looked likely for a while that the UK will leave the single market. And this week press reports suggested that the Government is preparing to lose the Supreme Court case, meaning that it still has to get a Brexit bill through parliament in order to trigger Article 50," says Hollingsworth.

Hollingsworth agrees with his contemporaries at HSBC and Standard Chartered that even if the UK is not a member of the EU single market, there are still a myriad of possible arrangements, with WTO rules only at the “harder” end of the scale, and a series of bi-lateral deal coupled with limited controls over migration and some budgetary contributions at the “softer” end.

"We doubt that the speech will cast much light over the exact composition of any new arrangement," says Hollingsowrth. However, other factors could also keep the pound low. Indeed, relative interest rate expectations between the US and the UK point to further weakness in cable in the near term"

By contrast, the Pound has performed a bit better against the Euro, and Hollingsworth believes the lingering political uncertainty in the Euro area could mean that this trend persists.

May’s speech will likely reveal more details of her negotiating aims on controlling migration.

So watch the migration/single market access interplay.

Markets believe this is a zero-sum game, while May believes she can wangle a compromise.

“If May continues to portray a hard-Brexit stance, markets will be focused on whether this continuation of GBP weakness will persist,” says a note from Barclays to their commercial clients.

Barclays see the following levels in play ahead of the speech:

“As EURGBP continues to test back above 0.8700, our traders see resistance at 0.87635 and support at 0.8630/0.8650 in the short term. For GBPUSD, we see support at 1.2000/1.2040, with resistance at 1.2320 ahead of 1.2440.”