GBP: A Florentine Renaissance - ING

"Theresa May’s speech in Florence has signalled a shift in the UK’s position towards an ‘economically rationale’ Brexit – one that seeks to reduce some of the medium-term economic uncertainty clouding sterling markets," notes Viraj Patel, Foreign Exchange Strategist at ING Bank.

Key quotes:

"While prospects of a two-year transitional period pose upside risks to our year-end GBP/USD and EUR/GBP forecasts of 1.33 and 0.90 respectively, we are reluctant to revise these until we see greater strides towards a transition deal being signed, sealed and deliver. Michel Barnier’s response to the speech implies that this may be one the focal points of Brexit talks over the coming weeks and months – and therefore we retain a constructive GBP outlook in the near-term."

"The knee-jerk move lower in GBP suggests that investors may have been hoping for a  clearer and more succinct speech from the Prime Minister, rather than a fairly ambiguous one that in effect takes us to the same destination: the UK will be looking for a two-year status-quo transition deal with EU once the Article 50 period transpires in April 2019."

"While below we note three channels through which an agreed transitional period, in principle, could unlock further upside potential in the pound – our economists remain wary of the fact that getting to this stage may not be straightforward. The response from Michel Barnier – the EU’s chief Brexit negotiator – was fairly amicable, but noted that a transition deal is subject to “the wishes” of the EU. While they have previously supported the idea of a status-quo transitional arrangement, the finer details – such as the exact budgetary and judiciary conditions of any transition period – still need to be ironed out."

"If a two-year transition deal can be signed, sealed and delivered swiftly – then we see three channels through which GBP could move higher: (1) reinforced BoE policy tightening sentiment in markets and a steeper UK rate curve; (2) a recovery in domestic investment prompting upside risks to the UK’s growth outlook; (3) a reduction in GBP downside tail risks stemming from cliff-edge Brexit risks being pushed further down the road."

"A combination of these factors would inject some modest upside to pound over the coming months, with GBP/USD potentially moving up to 1.38-1.40 by year-end. Equally, we could see EUR/GBP trade in a slightly lower range of 0.85-0.87 on a swiftly agreed transition deal."