GBP/USD: UK Parliament still likely to reject May’s Brexit deal

The much-anticipated delayed Commons vote is about 24 hours away now. Ahead of the vote, UK Prime Minister Theresa May has made a last-ditch attempt to persuade MPs to save her version of Brexit with a (dare I say, meaningless) speech in Stock-on-Trent earlier today. Meanwhile the UK government has also published the letter from the EU on the backstop assurances. Among other things, it states that the EU is committed to speedy work on trade deal by December 2020 to avoid triggering the Irish backstop arrangement and that it is willing to extend the transition period if needed. Essentially, the PM’s speech contained nothing we have not heard before, while the EU’s letter is just a clarification of the deal signed last year and it doesn’t contain anything new to change the minds of MPs tomorrow. So, as things stand, Theresa May’s EU withdrawal agreement still looks like will get rejected by the parliament on Tuesday.

Assuming the PM does get defeated tomorrow, the pound’s initial reaction will probably be a negative one. But what the pound does after its initial reaction will not only depend on the result but how close or otherwise her deal would have been from passing the meaningful vote. If it gets rejected, say, by only a handful of votes, then the PM could potentially tweak a few things without too much difficulty in her plan B – if there’s one –  which could then pass. She will be obliged to return with new proposals by Monday January 21. If her (revised) deal passes after the first or second parliamentary vote then this would most likely trigger a rally in the pound, for it will pave the way for a soft Brexit.

However, in the more likely event that she gets defeated badly then her plan B will have to be radically different for it to pass the second vote. A heavy defeat will increase the odds of other options, including crashing out of the EU without a deal, which, many believe, is the worst-case scenario. So, the pound, in this case, could fall even more sharply in term of initial reaction

BUT it is not as simple that, for a heavy defeat in Tuesday’s vote will increase the odds for another EU referendum, too. If the British public were to vote again, this time the results may well be different with the potential for some Brexiteers to change their minds, while there will be more, younger, people eligible to vote, which is likely to boost the remain campaign, judging by the breakdown of the 2016 votes. So, a heavy defeat for May’s plan tomorrow could mean that Brexit may not happen after all. As mentioned, this potential outcome will most likely to be negative for the pound initially but depending on the direction of the Brexit situation over the coming weeks, then potentially the pound could benefit if we head towards a second EU referendum.

It is also worth remembering that with much of the negatively already priced in, it is going to be unlikely that the pound will see the sort of a sell-off (in the worst-case scenario) we witnessed back in June 2016, when the outcome of the EU referendum vote shocked the markets. Indeed, given the above considerations, the pound could eventually stage a surprise rally even if Mrs May’s deal is defeated heavily, perhaps after an initial drop. So, whatever the outcome of the vote, we think the downside potential for the pound is limited.

In fact, the technical outlook of the GBP/USD is beginning to look promising. After forming a couple of doji candles in as many months, there is a hammer candle in the making on the monthly chart of the cable around the 1.26-1.27 long-term support zone (see the inset). Obviously, we are in the middle of the month, and the candle is subject to change. On the main daily chart, meanwhile, the GBP/USD has broken above its bearish channel and moved beyond the 50-day moving average. So, the path of least resistance looks to be to the upside for the pound, as things stand. However, we can’t ignore the fundamentals and importance of tomorrow’s vote. So, at this stage, we are proceeding with extreme caution despite the apparent bullish reversal pattern on the technical charts of the cable.