"A week ago it was far from clear whether PM May would hold on to her job beyond the weekend. The tensions surrounding May have died back for now, allowing GBP to recoup the losses suffered at the end of last week. However, as illustrated by the pound’s reaction to Brexit related news yesterday, the pound remains highly sensitive to political events," argue analysts at Rabobank.
"At the press conference that followed the end of the fifth round of Brexit talks yesterday, EU Chief Negotiator Barnier remarked that the dialogue had become deadlocked. This confirmed fears that there would be no start to trade talks this month. In turn this intensified fears that, with only 18 months left before the UK leaves the EU, there could be insufficient time to cobble together a deal. That said, after a sharp move lower yesterday, the pound recovered its poise within a few hours. News that the EU27 could launch its own internal preparations for a new relationship with the UK and that the Union is ready to talk about how to avoid a ‘hard Brexit’ brings renewed hope that the UK will not be leaving the EU in March 2019 without a deal. Also supportive for the pound are reports that the EU could offer the UK a 2 year transitional deal. Given that this was mooted by PM May in her Florence speech, this would appear to be another olive branch from the EU to the UK government. The endorsement of May’s 2 year transition period and the implication that the UK could still have access to the customs unions and single market until 2021 should remove some pressure on firms to put into action plans that assume a hard Brexit. This relaxation of uncertainty should be beneficial for business confidence. That said, it delays rather than removes the cloud of uncertainty that is handing over UK businesses meaning that downside risk for GBP have been dampened rather than removed."
"A Rabobank study published this week estimates that a hard Brexit would cost the UK economy 18% of GDP growth until 2030 compared to our estimates of growth if the UK remained within the UK. We estimate that the economic impact of a soft Brexit is far less severe. Yesterday’s brief GBP sell off highlights the concern that is embedded in the market regarding the possibly of no deal being in place in March 2019. It also suggests that investors are deeply concerned about PM May’s position that ‘no deal is better than a bad deal’."
"Over the next couple of weeks the market will be turning its attention back to the BoE’s November policy meeting. The market is mostly prepared for a rate hike, though there remains a lot of doubt as to whether the economic outlook justifies a move. We have previous argued that Carney’s hawkish commentary in September was aimed at stabilising the pound and that he had some success in doing this until the UK political backdrop soured in early October. However, if a November rate hike is accompanied by further signs that UK growth is sluggish, the market will assume (as we do) that the BoE may not be able to follow any policy move for a prolonged period. This suggests that while a November rate hike may have removed some downside potential for the pound, it is unlikely to be able to completely counter the political and growth risk that are undermining the pound. We see risk for EUR/GBP to move back to the 0.90 area on a 3 mth view. That said, if the EU and UK Brexit negotiations have not achieved significant progress by December, EUR/GBP could be trading closer to 0.92 on a 3 mth view. "
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