British Pound Tipped to Go Higher vs. Euro, Dollar as "Logic to Prevail" in Brexit Talks

Above: Theresa May, Jean-Claude Juncker. © European Union , 2017   /  Source: EC - Audiovisual Service

Both the E.U. and the U.K. will be better off buying more time and agreeing to at least a two-year extension - and this will be good news for Pound Sterling say Bank of America.

Foreign exchange market participants are left treading water as they await progress in Brexit talks, but recent market action betray the markets desire to take the British Pound higher.

Sterling leapt higher against the Euro, Dollar and other major currencies on December 4 after markets believed Theresa May was going to Brussels to sign-off on the tricky issues of the settlement bill, Northern Irish border and citizens rights.

They were mistaken; it was too early for such a finality, and Sterling pared its gains confirming once more how difficult it is to call the currency now that it is so politically-charged.

Yet the price action undertaken by the Pound tells us it is itching to go higher and progress, when it comes, will likely break it to fresh multi-month highs against both the Dollar and Euro.

The key takeaway from events in Brussels are that the E.U. and U.K. are both eager to settle the first stage of Brexit talks by mid-December when European Union leaders gather to discuss Brexit in detail.

European Council President Donald Tusk has reportedly cancelled a trip to the Middle East in order to get to work on the details of the next phase of talks - what will be offered to the U.K. in terms of trade.

"We still believe the European Council will agree at their 14 December meeting that sufficient progress has been made in phase 1 of Brexit negotiations, allowing trade talks to begin in the New Year," says Elias Haddad, a currency analyst with Commonwealth Bank Australia.

Such progress could come even earlier with European Commission President Juncker telling the press following his long lunch with Theresa May that "I’m very confident that we’ll reach an agreement in the course of this week".

"If the talks come to a positive conclusion we believe GBP/USD can lift towards levels around 1.3700," says Haddad, echoing sentiment amongst other strategists.

"I just don’t see either side saying it’s all fallen apart & back to the drawing board," says Neil Jones at Mizuho Bank in London, "the bottom line is Brexit breakthrough is to send the Pound higher."

The European Union's chief negotiator Michel Barnier has already laid out the sequencing of the next phase of talks and says discussion over a transitional agreement will be come next; something that will certainly suit the Pound.

U.K. businesses - and by extension the U.K. currency - are keen for the certainty that a transitional period provides and the sealing of a transition period automatically diminishes the prospects of a cliff-edge, hard-Brexit as it allows more time to thrash out the details of what will be an incredibly difficult deal to achieve.

"The negative scenario is a breakdown of the negotiations, no deal, and WTO rules, which is the worst possible outcome from Brexit, for next year and beyond," says Athanasios Vamvakidis, FX Strategist with Bank of America Merrill Lynch in London.

"We see zero probability of having a trade deal by the end of next year, as it usually takes much longer. The very slow progress, if any, in the negotiations so far, even though discussions on trade have not even started yet, does not justify much optimism that the discussions will move much faster from now on," says Vamvakidis.

Setting out their forecasts for the Pound in 2018, Bank of America Merrill Lynch Global Research say their baseline expectation is for a positive scenario which will ultimately be good for Sterling.

BofAML argue both the EU and the UK will be better off buying more time and agreeing to at least a two-year extension. "This will keep the uncertainty alive, but will postpone the final verdict and will be good news for GBP, in our view," adds Vamvakidis.

Recent client feedback from BofAML's extensive client base shows clients broadly agree with the view the U.K. and E.U. will agree a transition deal, but they believe it is too early to position for it.

A number of our clients "are even more optimistic", seeing a scenario in which postponing Brexit will allow for the UK public opinion to change and the UK may never exit the EU-this "may explain why some Brexit supporters are against having a transition," says Vamvakidis.

"It is too early to discuss such a scenario, but such views suggest to us that GBP could strengthen sharply if there is a transition deal next year. We would argue that GBP could even start appreciating sooner, if the EU decides on 14 December to start discussions on trade and transition," says Vamvakidis.

To position for a positive Brexit scenario next year and a transition deal, BofAML are "long GBP/CHF" - i.e. they are looking to profit from a trade that buys the Pound while selling the Swiss Franc.

BofAML forecast the Pound-to-Dollar exchange rate to end 2018 at 1.40 while the Pound-to-Euro exchange rate is forecast to end 2018 at 1.18.

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