Caution Urged on Pound's Recent Spike Above 1.15 vs. the Euro

Juncker and May will be central to Sterling's day

In the case of today's meeting between May and Juncker, no news will be good news for the Pound. Image © European Union, 2018 / Source: EC - Audiovisual Service / Photo: Etienne Ansotte.

- Pound Sterling spikes on perceived progress in Brexit talks

- But analysts say gains could come under pressure

- Eyes on May-Juncker meeting

- No news is good news for Brexit talks at this stage

Pound Sterling was the best-performing major currency heading into the mid-week session, rallying as markets sense potential movement in Brexit negotiations. However, gains appear to be coming off as we move through the late morning period in London with the Pound-to-Euro exchange rate coming off the day's high set at 1.1518 to quote at 1.1489 at the time of writing.

All eyes now turn to the mid-week meeting between Prime Minister Theresa May and European Commission President Jean-Claude Juncker in Brussels for confirmation of such progress.

The pair will meet to discuss ongoing negotiations centred on the Irish backstop clause contained within the Brexit Withdrawal Agreement.

A series of news reports point to progress on the issue, leading Sterling on a strong rally over the course of the past 24 hours.

The Pound-to-Euro exchange rate opened the week in the vicinity of 1.14 but on Tuesday, February 20 it rallied back above 1.15, on news that the Prime Minister has told her cabinet the so-called Malthouse Compromise was a non-starter but there are signs that progress on alternative solutions are in progress.

Rally in the Pound to Euro exchange rate

Above: The Pound has increased in purchasing power against the Euro.

The Malthouse Compromise was a plan hatched by remainer and Brexiteer elements in the Conservative party and was seen by many as the way to unite a party divided by Brexit. Surely the death of the Malthouse Compromise is therefore a bad thing for Sterling then, as it sought to create a plan that a parliamentary majority could unite around?

Not necessarily, as the message taken by markets is that a new, more credible solution has been found, indeed the Malthouse Compromise was regarded by the European Union as being a non-starter and a dogged pursuit of the plan only raised the prospect of the EU and UK falling into a 'no deal' divorce.

Harry Cole, Deputy Political Editor of the Mail on Sunday reported the developments on Tuesday, saying he saw the "faintest wisp of white smoke," as he is told by his sources "Downing Street and UK negotiators were “pleasantly surprised" at how well talks went yesterday and there is rapid movement behind scenes."

Confirmation of any progress will come from today's meeting of May and Juncker. However, we expect limited communication from the two and would actually suggest that 'no news is good news' at the current juncture.

As noted by Oliver Wright, Policy Editor at The Times: "No news means good news with Brexit talks... in the short history of Brexit negotiations a good rule of thumb has been that the less you hear the more progress is being made."

Wright adds:

"Brexit chatter has gone suspiciously quiet.

"There are small signs that, in contrast to the rhetoric of two weeks ago when Theresa May visited Brussels for negotiations with the Commission president, Jean-Claude Juncker, significant progress is being made."

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Wright says there are two limited compromises coming from both sides:

"From the British side the compromise is a realisation that the EU will not specify a date for the backstop ending or consider the so-called Malthouse compromise that would remove the backstop altogether.

"From the EU side it comes from a realisation that the withdrawal agreement is contradictory: while it says that the backstop should be temporary its legal effect would be to make it potentially indefinite. This is something they are now prepared to discuss."

Talks on Monday between the EU's chief negotiator Michel Barnier and the UK's Brexit Secretary Stephen Barclay and Attorney General Geoffrey Cox are said to have overran, with a planned speech by Cox scheduled for Tuesday being rescheduled.

We believe that when markets got wind of the speech's cancellation they started buying the Pound as the delay amounted to a signal that movement was afoot.

Barnier, Barclay and Cox are scheduled to meet again on Thursday, with lawyers on both sides said to be engaged in trying to agree an acceptable form of language to bridge the impasse.

While Sterling has enjoyed gains, we hear from some analysts that it is wise to maintain a cautious approach to Sterling in then current environment.

Petr Krpata, a strategist with ING Bank N.V. says Sterling rallied in response to news about potential progress on the Irish border issue, "yet, with EU officials remaining cautious and the previous experience of the UK government failing to offer a tangible or realistic alternative proposal, the potential lack of progress today may reverse some of GBP gains."

The reversal could be particularly pronounced against the Euro as "GBP is trading 2% expensive vs EUR based on our short-term fair value model at this point," says Krpata.

The problem for May is that she has to satisfy a contingent of ultra-Brexiteers in her party who would likely only vote for the Brexit deal were the Withdrawal Agreement be reopned and the backstop removed.

The EU has steadfastly rejected such an approach, suggesting May has to magic up a solution that allows one of the two parties to cross a red line.

"The expectation is that PM May will focus on the two other options for ensuring that the UK is not trapped indefinitely in the backstop – a time limit or some form of termination clause. While optimism is high, there may still be too much time left before the final date of the 29th of March to focus the attention of both sides," says Lee Hardman, a foreign exchange strategist with MUFG in London.

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