EUR/GBP bulls in charge as Brexit risks loom

EUR/GBP is currently trading a 0.8747, +0.39% on the day having travelled from a low of 0.8697 to a high of 0.8756. The pound is taking most of the heat from USD strength today with cable falling over 1 big-figure and to the lowest levels of the month ahead of the Bank of England later this week. 

There is a great deal in play for the FX space, but there is favouritism to dollar-denominated assets (higher-yielding treasuries and more resilient stocks compared to ROW equities) which should continue to underpin the USD going forward, weighing on both GBP and the EUR. As for the cross, EUR/GBP has recovered from the end-of-month flows lowest levels since March. EUR/GBP has since climbed 2.94% as Brexit risks come back to the fore. 

Brexit-clock ticks away in the background

Brexit has also resurfaced as an emerging political narrative which should also pressure both the pound and euro, with an emphasis on sterling in the main. The clock is ticking as the EU has said no extension would be possible unless it is agreed by the end of June. Negotiations have started this year, but engagement levels are low and both sides are still very far apart on a number of areas. The next round of talks is scheduled to begin May 11.

The risks associated with a hard Brexit leaves GBP vulnerable in coming months as the prospects of the return to WTO rules on trade from January 2021 will weigh. The WTO scenario opens the risk of confusion and delays at UK borders is a concern for investors.

"The first real deadlines are nearing fast," analysts at TD Securities explained. "There has been little progress in the negotiations, and the pressure on the UK government to ask for an extension of the transition period is building."

The arguments to buy more time are compelling. But if Brexit was built entirely on rational arguments, the UK government would have already sought for such an extension by now. Once again, an eleventh-hour decision appears to be the most likely. In the meantime, there is little choice but to take the government at its word that there will be no extension.

This is a notion which is being reflected in the media.  Press reports are suggesting that UK negotiators are threatening to walk away from talks with the EU over their relationship at the end of the Brexit transition phase. When you couple that with the WTO rules confusion, a recession and COVID-19, that is a very toxic cocktail for sterling. 

"With the July 1 cliff edge now fast approaching, we think the return of Brexit risks could become a tradable theme for sterling again. GBP's higher-than-average premium makes it vulnerable," analysts at TD Securities argue. 

BoE forecasts will be key

We will have the Bank of England later this week whereby the Monetary Policy Committee is expected to keep the benchmark interest rate unchanged at 0.10%. The rate decision and the Monetary Policy Report will be published in the early morning at 7 AM London time; a briefing will be made public at 10 AM.

The MPC is expected to push back on the idea of a ‘V-shaped’ recovery which is plausible considering COVID-19 will linger for longer and the risks of waves of outbreaks and spikes in contagion is a real probability.  Businesses can not just get back to work in full capacity and the process of doing so will be very slow as companies will be reluctant to hire staff too soon.

Analysts at Rabobank argued that,

even as there are no expectations for policy changes going into this meeting, the MPC’s outlook will gather a lot of interest. We will see the first set of official forecasts that incorporates the impact of the Covid-19 pandemic. While we think that the Bank of England will eventually have to increase the size of its Asset Purchase Facility again, we only expect such a decision at the June meeting.

EUR/GBP levels