UK: Noisy speeches may see GBP trade with a Brexit risk premium - ING

It may be wishful thinking to expect the next few weeks to go smoothly for GBP as the UK government unveils its Brexit vision over the coming weeks, suggests Viraj Patel, Foreign Exchange Strategist at ING.

Key Quotes

“Indeed, the key risk is that prominent Brexiteers could muddle the landscape – reducing the perceived odds of a Brexit transition deal being agreed by end-March. Such uncertainty would likely command a modest Brexit risk premium priced into GBP in the near-term.”

“Historically – and since the Brexit referendum – we’ve seen some pretty sizable short-term risk premium’s being priced into GBP during ‘noisy’ Brexit episodes. As the chart below shows, GBP/USD has at times traded around 1.5-2.0% below it’s expected short-term fair value model estimate – although we note the biggest discrepancies were seen mainly during the first 6-12 months after the Brexit vote (so up until 1H17).”

“Of late, however, we’ve rarely seen GBP/USD trade with any meaningful discount – a potential sign of Brexit fatigue and evidence that there is now a high bar to sell the currency on the back of Brexit or domestic UK politics. In fact, more recently we have seen GBP/USD trade at a sizable premium relative to its fair value estimate, though we chalk this down to a structurally and politically weak USD (see our note outlining the four misconceptions for GBP/USD right now).”

“Should noise levels around Brexit increase over the coming weeks, we would expect GBP/USD at best to trade with a 0.5%-1.0% risk premium. We would expect a similar – albeit slightly bigger – risk premium to be priced into EUR/GBP. In terms of levels – and assuming the conservative assumption of no change in our fair value estimates – heightened Brexit noise could see GBP/USD trade in the 1.3720-1.3950, with EUR/GBP bouncing around the 0.88-0.90 region.”