British Pound: Barnier’s “Brexit Education” Comments Open Door to Fresh Scenarios on Sterling Outlook vs Dollar and Euro

• FX Quotes:
• Pound to Euro exchange rate: 1 GBP = 1.0886 EUR
• Pound to Dollar exchange rate: 1 GBP = 1.2942 USD

Whilst the U.K. economic data calendar hots up over coming days, politics will never be far away as a driver of Pound Sterling.

Of particular interest is the evolving political stances on either side of the English channel concerning Brexit following the completion of the third round of negotiations.

A headline over the weekend confirms what many in the U.K. fear: the E.U. intends to make an example of the U.K. for its decision to exit the E.U. with chief negotiator Michel Barnier stating negotiations offer an opportunity for the E.U. to "teach the British people and others what leaving the EU means".

"I have a state of mind - not aggressive... but I'm not naïve," Barnier told the Ambrosetti forum. "There are extremely serious consequences of leaving the single market and it hasn't been explained to the British people. We intend to teach people… what leaving the single market means."

Barnier told a conference in Italy on the weekend that while he did not want to punish the U.K. for leaving he did confirm  Brexit would serve as an "an educational process" for the British. In this instance, we see a very fine line between punishment and education.

Our initial take on Barnier's comments are that they are negative for Sterling.

This confirms our view that the E.U. are in fact not in the mood for negotiating; rather they are placing a prescribed set of conditions down before the U.K. which must be accepted, or no deal will be forthcoming.

This could well see the E.U and U.K. adopt a set of W.T.O trade rules which will govern their future trading relationship.

Brexit negotiations have now passed three rounds, with some progress being made but the E.U. are keen to make it known that none of their initial objectives - particularly on receiving a payment of ~€100BN from the U.K. on its exit from the Union - have yet been agreed.

The U.K.'s chief negotiator David Davis has confirmed even €50BN is a figure the U.K. will likely reject.

Until the E.U. greenlight the first rounds concerning the technicalities of exit, they are not willing to discuss trade. This leaves Sterling prone to the risk that a disorderly exit takes place.

But there is the chance Sterling is actually at a nadir when it comes to Brexit, for the time being at least.

The big question we are however asking is whether or not Sterling fully reflects such a disorderly Brexit. If it does, then presumably the currency will become increasingly immune to negative newsflow concerning the negotiations. If not, then substantive downside must be negotiated.

“We share the market’s worries about the economic impact from Brexit and maintain our cautious outlook for GBP in the near term. That said, we believe  that a lot of negatives seem to be in the price of the currency and thus expect a less pronounced sell-off from current levels,” says Manuel Oliveri, an analyst with Credit Agricole.

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Another question to ask, from a currency perspective, is how will dynamics change were the E.U. to be exposed as simply seeking to punish Britain? How does such a stanceimpact on internal E.U. politics, particularly for countries such as Ireland and the Netherlands which rely heavily on their exports to the U.K?

German manufacturers also rely heavily on the U.K. market and one would expect a clash of economic interests and the political ideology as pushed by Barnier, Juncker and Verhofstadt.

Right now there has been a sense of unity amongst European states but it will not likely last if some countries faces domestic slowdowns on Brexit.

Can pragmatism push the E.U. into a friendlier approach? If the answer is yes, it would certainly benefit Sterling and add to the narrative that the worst possible outcomes are in the price.

Another question for those trying to anticipate the direction of politics and Sterling is to consider whether comments of "educating" the British sit well with the British people?

Recall saw how Theresa May found a rise in support on her robust response to Jean-Claude Juncker after he labelled her a difficult woman following a dinner in Downing Street. Voters tend to respond well to those defending them, and this might be the case should a seige mentality be established on the back of a daily barrage of warnings and threats from the E.U.

We would suggest that the Government's position on Brexit, and the Conservative Party by extension, might find some support were they to be seen as standing up to the E.U. and having a more flexible approach to negotiations.

The Government's position on Brexit, and the Conservative Party by extension, might find some support were they to be seen as standing up to the E.U. which is looking increasingly aggressive and intransigent in its approachh to Brexit.

And a more secure hand for the Conservative Party would play well for Sterling as a fragile ruling class makes for uncertainty, and the Pound hates uncertainty.

The prospect of five years without another uncertainty-inspiring vote will be welcomed.