The E.U. Aren't Negotiating, and Pound Sterling Might Have to Fall Further to Reflect this Reality

• Spot market quotes:
• Pound to Euro exchange rate today: 1 GBP = 1.0850 EUR
• Pound to Dollar exchange rate today: 1 GBP = 1.2919 USD

Above: David Davis, Michel Barnier (C) European Commission.

The British Pound is presently taking direction from other currency pairs such as EUR/USD and global market conditions, but traders will soon focus on Brexit again.

The third round of negotiations are underway in Brussels with a conclusion to the current round due on Thursday, August 31.

The assessment delivered by E.U. negotiator Michel Barnier following the completion of these talks will be key to Sterling direction we believe; if he says progress has been made then we would expect Sterling to pop higher.

But if he reveals there is more work to do, and that the two side remain far apart, we would expect selling pressures to resume.

We believe a great deal of work needs to be achieved for a Sterling-positive outcome to be delivered. But we also believe there are growing hints that the E.U. is not at the table to negotiate, and the market might not fully appreciate this point.

The latest assessment delivered by the President of the European Commission, Jean-Claude Juncker, on August 29 to the release of the U.K's recently published position papers was of concern.

Juncker told the ambassador’s conference on Tuesday morning: "I would like to be clear that I did read with the requisite attention all the papers produced by Her Majesty’s government and none of those is actually satisfactory.

"So there’s still an enormous amount of issues which remain to be settled. Not just on the border problems regarding Ireland and Northern Ireland, which is a very serious problem in respect of which we’ve had no definitive response, but we also have the status of European citizens living in the UK and UK citizens living on the continent."

The comments are made despite the E.U. itself not having issued any formal position paper on the Ireland question.

Juncker's view echoes the initial assessment delivered by the head of the European Parliament, Guy Verhofstadt, to a position paper regarding future customs arrangements was that the U.K.'s proposals which he said amounted to "a fantasy".

The E.U. appears to be driving a hard line and there is the sense that only an acceptance of the E.U.'s position will be acceptable for talks to progress, particularly when the views of figureheads such as Verhofstadt and Juncker are accounted for.

Therefore, how much can be truly negotiated in these negotiations is questionable.

Analyst Christian Alpet at Germany's Helaba Bank is not convinced that the U.K. and E.U. will be able to agree a meaningful transitional agreement within the time remaining within which to negotiate ahead of Brexit in March 2019.

Indeed, Alpet believes the Europeans will “for tactical reasons” not initially agree to any transitional period; something that is crucial for Sterling's outlook.

The E.U. have boxed themselves into a corner by staggering the talks - they insist the Irish border, rights of E.U. citizens and the exit bill be settled before progressing to talks on the trade relationship. But, the Irish border is itself a question of trade, and seperating the two is nigh impossible.

The question of the final bill - a notable sticking point for negotiations - can also only be realisticly settled once the final relationship regarding customs and market access is established.

Contributions are a function of future benefits accrued from Europe; furthermore, the legalities surrounding the exit bill has not been provided by Europe.

What matters for the Pound's outlook from here is that the E.U. is looking increasingly willing to let the Brexit deadline of March 2019 lapse in order to reinforce the message of European supremacy.

This could ultiamately result in a disruptive Brexit and there is certainly further weakness in Sterling to be had if this is indeed the outcome.

"There is naturally some focus on whether EUR/GBP could reach parity but we regard that as being much too aggressive in the absence either of an outright UK recession or the failure of Brexit negotiations that heightens the risk of a disruptive Brexit in 2019," says Paul Meggyesi at J.P. Morgan.

J.P. Morgan say the long-term risk to GBP from a disruptive Brexit has diminished as "most players in the government now accept the need for a transitional deal that will ensure very little changes on the ground for a handful of years after 2019."

What J.P. Morgan and other analysts might be missing is an hard-headed approach from Brussels negotiators. We find little research literature available to account for the possibility that the E.U. will not give an inch.

"There needs to be some positive catalysts for GBP to manifest, not least signs of a stabilisation in a slowing UK economy and greater progress towards a Brexit transition deal," says Viraj Patel at ING Bank N.V.

The prospect of Brexit talks providing that positive catalyst appears distant at present and after multiple concessions being made by the U.K. it is now Europe's turn to show that it is at the table to negotiate, and not dictate.

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