Pound faces next Brexit barrier amid cautious wait for progress

The pound was last down 0.3% at US$1.2467, not far from the 27-month low reached last week, having declined 1.8% against the dollar so far this month. Against the euro, it also fell to 89.98 pence.

LONDON: As Brexit talks enter a crucial phase this week, pound traders are cautiously awaiting signs of progress toward a transition deal. Even if those expectations are met, any gains in the currency may be short-lived.

While U.K. Brexit Secretary David Davis has expressed confidence that a deal on the exit terms and the transitional period was “within reach” ahead of the March 22-23 European Union summit, investors remain far from convinced. 

BlackRock Inc. said last week that sterling’s near-term direction remains unclear even as a big move is expected, while a Barclays Plc survey found that most respondents didn’t expect an agreement until at least October.

Nomura International Plc expects an accord this week and recommends a long position in the U.K. currency against its Canadian counterpart. Aberdeen Standard Investments and Rabobank see any pound appreciation as brief, given longer-term challenges faced by Britain including that of reaching a post-Brexit trade pact with the EU. 

The Bank of England’s meeting on Thursday is also in focus, with investors watching for hints that the central bank is ready to raise interest rates as early as May.

“My expectation is that we get some sort of fudge this week,” said Liam O’Donnell, a money manager at Aberdeen Standard. 

“You can see some support for the pound on headlines for a deal but the market is likely to remain skeptical of the May government’s ability to keep all sides on board.”

The U.K. currency was around $1.3920 on Friday, and near 88.25 pence against the euro. The yield on 10-year U.K. government bonds was at 1.43%.

The biggest stumbling block to the transition deal so far has been the Irish border, with U.K. Prime Minister Theresa May saying, following the first draft, that no U.K. leader could accept such a deal. Although it’s looking more likely that a compromise will be reached in time for the EU summit, this could mean the problem resurfaces further into the talks.

“The fact that the parties seem to have a lot of work to do before a trade pact is announced should mean that any relief displayed by the pound is likely to be measured,” said Jane Foley, head of Group-of-10 currency strategy at Rabobank.

Ahead of the BOE meeting, a hawkish shift of stance by the central bank is largely priced in for sterling. Market pricing currently suggest an 80% chance the bank will raise borrowing rates in May, up from just 5% at the start of February.

Higher stakes
That probability could move up to almost 100% if a transition deal with the EU is reached, provoking a selloff in front-end gilts, according to John Wraith, head of macro rates strategy in London at UBS Group AG. While this is “perfectly logical,” it won’t last, he said.

“The stakes are going to get rapidly higher so if you’re going to get short-term relief reflected in a stronger sterling, higher short-end rates, a more hawkish MPC, it will prove short-lived,” said Wraith, who sees the pound dropping to $1.37 by year-end. 

“Once you get through the next week or two, we would expect opportunities to receive front-end rates and we still think in the fullness of time, sterling will weaken further.” - Bloomberg