"Scope for the Pound to Strengthen" - Bad News on Brexit Negotiations 'in the Price"

Above: Theresa May, (C) European Commission

A "No Deal" Brexit is looking increasingly likely but with the Pound having already fallen sharply during October, and a possible rate hike from the Bank of England just weeks away, some strategists say much of the bad news is already priced into markets.

Risks to the Pound remain elevated as October’s European Council summit draws to a conclusion on Friday with the remaining EU 27 leaders getting together without the UK to talk about Brexit and recalibrate their views.

Leaders heard from UK Prime Minister Theresa May on the previous day, but it is widely expected that the conclusion which will be reached is that the UK has not yet yielded to their will to a degree that warrants discussions over trade.

President of the European Council Donald Tusk said Wednesday that he will ask the EU to begin internal preparations to move Brexit negotiations onto the next stage of talks, about trade. But he also said that more "concrete proposals" are needed in order for there to be “sufficient progress” by even the December summit.

The air of uncertainty is likely to keep the Pound under pressure.

"The EU27 is almost certain to say that the Brexit talks have not made "sufficient profress" to move to the second phase of discussing trade," says Guy Stear, an economist at Societe Generale.

“Uncertainty over Brexit negotiations is likely to add pressure also on Sterling, given the slow progress that has emerged so far and despite PM Theresa May’s vow to accelerate talks with the EU in the months ahead,” says Chiara Silvestre, Economist at UniCredit CIB in Milan.

Silvestre cites press reports stating that Theresa May will not increase her €20 billion offer to Brussels at the forthcoming summit as grounds for thinking the “sufficient progress” hurdle set by the EU will not be met in the near future.

Deal or No Deal?

The BBC reported Thursday that May will make a further offer relating to the post-Brexit residency rights of European Union citizens in order to move talks along.

Reports of May's gambit to push talks along came amid revelations that the EU has invited opposition leader Jeremy Corbyn to Brussels during the summit and that officials will meet with him before they meet with May.

They also against a backdrop of pressure from conservative-leaning newspaper, The Telegraph, which carried a letter from a Brexit supporting pressure group on its front page. 

Written by a coalition of MPs and business people, the letter calls on Theresa May to walk away from the table in Brussels if EU officials will not agree to move discussions forward onto the subject of trade.

The Telegraph also claims to have been briefied by EU officials that Brussels will not agree to begin talking trade until May agrees to pay into the EU budget until at least 2023.

This means payments for two years more than the UK electorate have been led to expect and would double May's earlier offer of €20 billion, which comes in the form of continued budget contributions for an extended period after the point of "exit".

"The impasse between the UK and EU on what the former needs to pay before the latter initiates trade talks is turning contentious and causing investor concern. The political stalemate is raising uncertainty and the probability of a “hard Brexit”, both of which are negatives for GBP," says Jiangang Dou, a quantitative analyst at BNY Mellon.

“The recent move higher in UK yields has offered only limited support for the Pound so far, given ongoing concerns over Brexit and political stability in the UK,” says Lee Hardman, a currency analyst with MUFG.

A possible delay to the progression of talks on to the subject of a transitional deal till beyond December is something that is seen as raising the risk of a so called “hard Brexit”, or a “no deal Brexit” - which would be negative for Sterling.

“We do not expect that dynamic to change in the near-term, although the Pound does appear modestly undervalued according to our short-term valuation model. It creates scope for the Pound to strengthen if Brexit and/or UK political stability concerns ease,” says Hardman.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.

But How Much Lower Can Sterling Really Go?

With the Pound having already fallen sharply during the first half of October, and a possible rate hike from the Bank of England just weeks away, some strategists are also suggesting that much of the bad news likely to come from the summit is already priced into markets.

Often when sentiment reaches extremes - as is the case with negativity towards the Pound - it requires headlines to become ever more negative, which is unikely.

In such scenarios, the bigger moves are actually to be found in response to counter-trend headlines i.e. good news might have the bigger impact on moves in the Pound.

In short, beware of the prospects of a relief-style rally.

“Well supported central bank rate expectations should prevent the currency from facing bigger downside risks, especially as a lot of negatives with respect to politics seem to be in the price by now," says Manuel Olivieri, a foreign exchange strategist at Credit Agricole.

The depressed level of the Pound could mean the risk-reward ratio available for speculators adding Sterling long positions will be favourable in the event of a positive surprise, or signs of progress in the negotiations, emerges at the summit.

"Although September’s retail sales figures were far weaker than expected, growth still maintained a fairly
reasonable pace over Q3 as a whole," says Ruth Gregory, a UK economist at Capital Economics. "As a result, we doubt that today’s figures will dissuade the MPC from hiking interest rates on November 2nd."

In addition, and despite the recent noise in some UK economic data, some forecasters remain optimistic in their outlook for the UK economy. 

"We get the first print of Q3 GDP next week, and our models are still pointing to upside risks compared to the BoE's forecast from Sept, so the overall picture for the UK is still looking okay," says Jacqui Douglas, chief European macro strategist at TD Securities.

Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.

Data Woes

The Pound-to-Euro echange rate rate took a dive Thursday after official data showed UK retail sales slowing faster than was expected during September.

High street spending contracted by -0.8%, more than the -0.1% fall forecast by economists, with the Office for National Statistics citing a fall in takings at non-food stores as the culprit.

The Pound-to-Euro rate was quoted 0.62% lower at 1.1135 by the London close. It has fallen by 0.70% during the week to date and by 1.21% so far in October.

Sterling remained under pressure against the Euro throughout the London session despite the common currency having taken a knock itself in response to the latest developments in the Spanish constitutional crisis brought about by a renewed Catalan push for independence.