Where now for Sterling?

As is often the case with financial markets, the last couple of weeks have been a classic case of buy the rumour, sell the fact. Two weeks ago, sterling was trading just above $1.30, up almost 3% from the previous week’s low amid speculation that Theresa May was set to announce a Brexit deal that would avoid the UK crashing out of the European Union on 29th March 2019 without a trade deal. However, by Thursday last week, the pound had tumbled back to $1.2724 following publication of May’s proposed deal which was widely criticised and prompted the resignation of Brexit secretary Dominic Raab and arch Brexiter Esther McVey.  
To say reactions to May’s proposal have been mixed would be an understatement. While she has a number of supporters who appear to believe that the deal is as good as the UK is likely to get, there is a growing number of dissenters who believe that a change of leadership is needed to negotiate more favourable terms. Yesterday, Sir Graham Brady, Chairman of the Tory Backbench 1922 Committee, said that he had not yet received the 48 MP’s letters needed to trigger a confidence vote. We know the number of letters currently exceeds 20 and former pro Brexit minister Steve Baker has claimed that the number is now very close to 48, so it won’t be a big surprise if the threshold is reached this week. 


Either way, the uncertainty looks set to result in additional volatility in the coming weeks with the focus on the downside for sterling. Risk appetite is likely to remain under pressure (although the FTSE 1000 is likely to be cushioned by a weaker pound) and consumer confidence will also take a hit (but no doubt shoppers will still be looking to take advantage of Black Friday bargains). Betting markets are currently pricing in around a 30% probability that Theresa May will not be PM by the end of 2018 but only a 1.5% chance that we have a general election before the end of the year.


Back in September, we summarised three main Brexit scenarios and our views about the probability of each outcome as follows:




At the time, GBPUSD was trading at 1.31 and GBPEUR at 1.1150. Today, sterling is slightly softer against the dollar at $1.28 but a touch firmer against the euro at €1.1250 (little changed in the grand scheme of things). In our view, this reflects the fact that the probability of a deal / no deal is still around 50%. We do see a small change however between the probability of a negotiated deal (i.e. Theresa May’s proposal being accepted by both the House of Commons and European Leaders) and no Brexit. In light of the reaction to May’s deal, we see a reduced probability of a soft Brexit (upon which we now place a 25% probability) thereby increasing the probability of no Brexit (following a second referendum).  


New summary as follows:





Ultimately, we still see the same asymmetry in the risks for sterling. If Britain were to leave the EU without a trade deal, we envisage sterling falling (circa 10%) to $1.15 and €1.05 very quickly. If a deal is struck, we expect sterling to rally, but only by around 5% as both political and economic uncertainty lingers.   





Author: Marc Cogliatti


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