Sterling prices in little no-deal Brexit risk premium – MUFG

The pound has continued to underperform amidst more risk-averse trading conditions. It has resulted in EUR/GBP rising back towards the 0.9000-level and cable falling towards the 1.3100-level. Market participants have been unnerved by the negative Brexit headlines, therefore, the pound has room to the downside as a no-deal outcome is not priced in, per MUFG Bank.

Key quotes

“The latest IMM report revealed that the pound’s recent upward momentum had encouraged leveraged funds to begin building modest long pound positions which are now being tested by heightened Brexit uncertainty. In the past, the pound has become more undervalued as Brexit risks increased. It leaves plenty of scope for the pound to weaken further should market participants price in more of Brexit risk premium to reflect the increasing risk of a more disruptive no-deal outcome.”

“Recent price action still suggests that market participants remain confident though that a compromise Brexit deal will be reached at the last minute. The underlying belief being that neither the UK nor European governments would want to deliver another negative economic shock on top of the unprecedented COVID hit. Such optimism has helped to dampen downside risks for the pound so far from the lack of progress in Brexit talks.”

“We now expect that optimistic view to be tested more thoroughly in the coming months. At the very least it should encourage a more volatile pound in the run-up to the new self-imposed trade deal deadline of 15th October. The balance of risks is more skewed to the downside for the pound given that it appears to be pricing in little risk of a no-deal outcome at present.”