Fudge in the Making: Pound's 2019 Recovery might be Delayed as Negotiators Shave Ambitions for Brexit Withdrawal Agreement

Above: Negotiators Raab and Barnier might only be able to deliver the bones of an agreement by year-end. Image © European Union, 2018 / Source: EC - Audiovisual Service / Photo: Lukasz Kobus.

- Widely held assumption is that Sterling can recover in 2019 on Brexit clarity

- But, Brexit negotiators appear to be shaving ambition of 2018's Withdrawal Agreement

- "More difficult and contentious discussions over the future trading relationship could be kicked down the road" - MUFG

Some potentially bad news for those wanting a stronger Pound Sterling: the currency's recovery might be delated as it is unable to rid itself of political uncertainty next year.

According to two prominent foreign exchange analysts, it appears Sterling might be lumped with a good dose of Brexit-related uncertainties in 2019 as negotiators appear prepared to slim down their ambitions on the deal they are trying to achieve by November 2018.

And any continuation of this uncertainty will ensure the Pound continues to bumble along around its currently discounted levels against the likes of the Euro and US Dollar, denying it the recovery expected in the event of a withdrawal agreement being signed.

"With time running out, the prospect that much of the discussion over the detail
will be kicked into the transition period suggests that GBP will not be able to rid itself of political risk next year," says Jane Foley, a foreign exchange strategist with Rabobank in London.

A working assumption by many foreign exchange analysts is that much-needed Brexit clarity will be provided by year-end 2018 as the Withdrawal Agreement is signed, allowing businesses and individuals to start making investment decisions once more.

Investors would meanwhile be able to take the Pound higher back to 'fair value' levels.

But, this week a key piece of information hit the newswires: UK and German officials appear happy to slim down the ambitions of the Withdrawal Agreement to ensure a deal can be in place by November 2018 at the latest.

This would then in turn allow national parliaments to accept the deal and ensure a smooth Brexit transition takes place starting in March 2019.

The Pound rallied on the news: the Pound-to-Euro exchange rate leapt to a weekly best at 1.1165 while the Pound-to-Dollar exchange rate recorded a best at 1.2982.

However gains were tempered as 1) the claims made by the newswire were officially denied and 2) a creeping realisation crept on markets that any deal achieved in 2018 might not actually deliver the clarity they are yearning for.

"The short, sharp surge in the value of Sterling followed a Bloomberg report which suggested that the EU and the UK were planning to announce a broad, abbreviated Brexit deal. While this would indicate that progress has been made in the negotiations, it would also imply that much of the discussion around the details would be kicked into the post Brexit transition phase. The Pound gave back many of its gains fairly quickly, though it is still holding well above yesterday’s weakest levels," says Foley.

The key sticking point to negotiations remains the Irish border: neither sides want a border for the trade in goods, but there must evidently be some kind of border if Northern Ireland and the Republic are to move into two separate customs regimes.

The EU ultimately wants Northern Ireland to remain in the EU customs union if the rest of the UK diverges and adopts independent customs policies; the UK will however not contemplate a border between Northern Ireland and Great Britain.

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Sterling Glued Down by Sticky Fudge in 2019

The puzzle posed by the Irish border question looks too complicated to solve anytime soon; and with it the question of trade remains unanswered.

"While a trade deal would be good news for the Pound, upside potential could be limited if another fudge is announced and a true solution for N.Ireland  remains elusive," says Foley.

'Fudge' is also adopted as an apt word to describe the latest Brexit developments by Lee Hardman at MUFG.

"The need for another Brexit fudge has risen after the Chequers plan received a mixed response both at home and across the EU. It could also be one way to help resolve the Irish border backstop, which is the main outstanding issue required to finalise the withdrawal agreement. The more difficult and contentious discussions over the future trading relationship could be kicked down the road," says Hardman.

For Hardman, any potential Brexit fudge exposes the Pound to "implementation risks" - opposition parties are likely to be concerned over voting to leave the EU without more clarity over the form of the future trading relationship.

Members of the ruling Conservative party might meanwhile "rightly acknowledge that the UK would lose even more leverage in negotiations after the withdrawal agreement is signed off."

This therefore keeps alive the threat of a 'no deal' as the UK parliament would be required to vote through the terms of the final Withdrawal Agreement to ensure the transition period that kicks in on Brexit day on March 29 actually comes into place.

It is this fear of a 'no deal' that has hurt Sterling and can be traced via the Pound's downtrend that has been in place against the Euro and Dollar since April.

Above: Sterling's downtrend against the Euro reflects increasing fears that the EU and UK might fail to finalise the Withdrawal Agreement before Brexit day in 2019.

"We still believe that the risk of an immediate 'No Deal' is overstated," says Hardman; a view shared by the majority of foreign exchange analysts we follow.

But ultimately this all ensures the recovery in the British Pound is delayed.

"The negative implication of another Brexit fudge would be that heightened uncertainty over the form of the future trading relationship would remain elevated for longer which would still act as a dampener on upside potential for the Pound and the UK economy," says Hardman.

Rabobank meanwhile forecast the Pound-to-Euro exchange rate will recover back to 1.1628 by this time next year.

This forecast assumes "the bones of a trade deal are on the table before the UK leaves the EU in March 2019," cautions Foley.

On a 'no deal' Brexit, Rabobank sees a risk of the Pound falling to parity against the Euro.

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