GBP: Fingers crossed? - Rabobank

The pound is celebrating this morning on positive headlines regarding a Brexit transition deal and sterling is the only G10 currency to have outperformed the USD on a 1 day view on the assumption that the UK and EU Brexit negotiators will officially announce later today that a transition deal has in principle been agreed, explains Jane Foley, Senior FX Strategist at Rabobank.

Key Quotes

“Last week a UK government official reportedly signalled that progress had been made on the transition deal. However, unanswered questions have prevailed with respect to the border between Northern Ireland and the Republic of Ireland. When the EU/UK announced in December that a deal has been struck over the legacy issues connected with Brexit, the issue of the N. Irish border was effectively glossed over.  In recent weeks, reports in the press have implied that this ‘fudging’ is no longer acceptable by some parties involved in the Brexit negotiations.  The EU has proposed that in the event of no other solution being found, that N. Ireland should remain in the EU’s customs’ Union. PM May was quick to respond to this with the statement that no UK prime minister could accept such an outcome.”

“Since May relies on the unionist DUP party for support in parliament, she in particular, would not be able to support such a proposal.  The DUP will refuse any plan that appears to differentiate N. Ireland for the rest of the UK.  Insofar as the Irish government last year pushed for a guarantee that there will be no return to a hard border based on the risk of upsetting the peace process in the region, it is difficult to see where the compromise will be.  The UK has maintained that technology will be employed heavily at the border instead of traditional customs checks. However, there have been concerns that this may not be acceptable to the EU.”

“Over the weekend Reuters reported that a senior EU diplomate had indicated that a stalemate on the issue of the N. Ireland border still threatens to scupper on the transition arrangement, though other sources had noted quick progress on outstanding issues. Over the past 5 days the pound has rallied by almost 1.3% vs. the EUR and 1% vs. the USD on the anticipation of good news today, though further upside potential is likely if a deal is announced today bringing clarity on the issue of the N. Ireland border.  A joint press conference between EU Chief Negotiator Barnier and the UK’s Davis is expected later in the day.”

“In addition to politics, GBP should take some direction this week from economic news. The release of UK February CPI inflation data tomorrow is expected to show some moderation in price pressures as the impact of sterling’s 2016 plunge starts to work its way out of the index.  The Bloomberg consensus stands at 2.8% y/y.  Barring a far sharper drop in UK inflation, however, we would not expect too much market reaction from this release given the scheduled BoE policy announcement on Thursday.”

“Although steady policy is widely expected from the BoE this week, the market will be looking for clues as to the MPC’s position ahead of the forthcoming policy meeting in May.  As it stands, the market see a strong chance of a 25 bps rate rise in May, though the MPC is assuming that wage inflation picks up.  Although we see risk that the MPC will position itself for rate hikes in both May and November this year, the chances of a second 2018 hike is dependent both on strengthening wage data and on the assumption that the Brexit negotiations are smooth.”

“We see risk that anxiety regarding Brexit trade talks will weigh on the outlook for GBP on a 6 to 9 month view. That said we expect GBP to rally sharply on a 12 month view on anticipation that a last minute EU/UK trade deal will be announced.  We see EUR/GBP in the 0.84 area on a 15 mth view.”