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Pound Can go Higher on "Conciliatory" Johnson: Goldman Sachs

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- GBP/EUR at 1.1158 | GBP/USD at 1.2526

- Early days of Johnson Govt. offers potential for Sterling recovery

- UBS say Sterling at good value around current levels

- Sterling set for better end to week on perceived Brexit shift by EU

Foreign exchange analysts at Goldman Sachs have this week said they believe the Pound could be due some relief if the new Prime Minister opts to strike a more conciliatory tone with the EU when he enters office.

The British Pound has been grinding steadily lower since May when it became clear Prime Minister Theresa May's EU Brexit deal would not pass through parliament and her position had therefore become untenable, but it has over the course of the past 24 hours shown an intention to form a potential base against both the Euro and U.S. Dollar.

For now, currency strategists remain wary of any strength with many looking for it to be a temporary phenomenon as the prospect of a new Prime Minister who is open to leaving the EU without a deal has  risen sharply as the Conservative Party looks set to anoint Boris Johnson as its next leader, and the country's Prime Minister.

However, should the new Prime Minister strike a more constructive approach with Europe, Sterling might be able to recover further.

"With Boris Johnson widely expected to prevail, market attention has begun to turn to Parliament’s summer recess (July 25 to September 3), and the new PM’s likely diplomacy with EU capitals during that period," says Zach Pandl at Goldman Sachs. "If Mr. Johnson were to turn mildly more conciliatory over the near-term as he seeks to find a path for a cooperative exit at the end of October, this could see EUR/GBP pull back from its local highs, this could see EUR/GBP pull back from its local highs."

The high in EUR/GBP is at 0.9010, achieved on July 10, which translates into a low for GBP/EUR exchange rate at 1.1098.

During the leadership selection process Johnson has advocated leaving the EU without a deal should no new settlement be forthcoming from the EU by October 31.

Market pricing for a 'no deal' Brexit has understandably risen over recent weeks, coinciding with a record run of ten consecutive weekly declines for the Pound-to-Euro exchange rate and the UK currency has not yet recovered enough over the past 24 hours to avoid an 11th successive weekly decline.

The declines take the exchange rate close to Goldman Sachs' three-month target of 1.11, however there is the potential for this level to remain unbroken says Zach Pandl, a currency strategist with Goldman Sachs in New York who warns that there is a chance the new Prime Minister could adopt a more constructive tone with the EU.

Members of the Conservative Party are currently voting and the winner will be announced on July 22. 

The suggestion that Johnson might adopt a more constructive approach to EU partners is not an outlandish one, as Johnson himself has previously said he does not for a second believe a 'no deal' outcome will take place on October 31.

Johnson does appear intent on negotiating with the EU: critically we are not overly confident if this means a renegotiation, or a completely fresh negotiation. We suspect he will

"Beyond the very near-term, however, the outlook for Sterling looks highly uncertain, which markets have reflected with a sharp move higher in forward volatility," says Pandl.

Goldman Sachs maintain a structural view that is positive for the Pound, "as our economists continue to see low odds of a 'no deal' exit, and because investor underweights in UK assets are meaningful," says Pandl.

"But we will await more information - especially more clarity on Labour’s Brexit strategy - before recommending longs," says Pandl.

A 'long' recommendation is a recommendation to buy a certain asset, and strategists only make such recommendations if their conviction reaches a certain threshold.

So while there is the potential for Sterling to recover over coming weeks, we are not looking at the start of a new multi-week rally.

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UBS: Sterling at Better Values

The Pound has reached levels where it offers good value, says Dean Turner, an economist at UBS Wealth Management, and its downside potential from here is limited.

“We think Sterling starts to look interesting at around these levels, quite frankly,” says Turner, adding, “it starts to look attractive because if nothing else just on fair value alone Sterling is an extremely cheap currency right now.”

Since it is UBS’s base case that the UK will not leave the EU on October 31 without a deal, there seems little fundamental reason for a weaker Pound, especially considering the UK’s resilient economic data. Instead, it may be a case of ‘the only way is up’.

“The case for sustained selling of the Pound I find much more difficult to get on board with,” says Turner.

When the pound was previously at its current low levels - 1.24 GBP/USD and 1.10 GBP/EUR - which happened in December and January 2018/19, it was prevented from going lower as buyers started to pile in.

“Previously when we have seen Sterling this low and if we think back to February 2017 which was the Lancaster House speech and we saw that sharp drop when markets woke up and thought ‘Oh Theresa May really means Brexit’ we saw that for the Pound to sustain those levels was very difficult because we do start to see buyers come in,” says UBS’s Turner.

Another reason the Pound could get stronger is that UK assets are looking attractive as well which suggests portfolio inflows could be strong from foreign investors purchasing those assets.

“At the end of the day, Sterling assets are extremely attractive. The UK has a number of positive aspects going for it in terms of the corporate sector, but also in terms of what is happening in the bond market. It is one of the few Bond markets globally that still offers a yield,” says Turner in an interview with Bloomberg News.

And how low could Sterling go in the case of a n 'no deal' Brexit?

“If we were to see a no-deal outcome Sterling could fall as low as around 1.15,” says Turner. “It is still a possibility, but not our base case.

 

Sterling Recovers on Potential EU Shift

The British Pound rallied against the Euro, Dollar and a host of other currencies through the Thursday-Friday seession as some potentially positive comments from the European Union's Chief Brexit negotiator and Ireland's Prime Minister came through.

Newswires reported that Barnier - who leads Brexit negotiations with the UK on the EU's behalf - is ready to work on alternative arrangements for the Irish border; we believe the quotes are taken from an interview given by Barnier to BBC Radio 4.

The issue of the Northern Irish border has long been a stumbling bloc in both the EU and UK reaching agreement on a Brexit deal, any suggestions of a substantial shift in position by the EU will therefore be seen by some market participants as a potential game-changer as it provides a chance for the UK's House of Commons to finally get behind an ammended Brexit deal.

"Barnier says open to Alternative Irish Border plan. Sequence of events post Tory PM being elected on 22 July points to renewed UK-EU talks and optimism for a Brexit deal. Oversold GBPUSD has asymmetric headline risks (more sensitive to positive over negative). Bullish hopes," says Viraj Patel, a foreign exchange strategist with Arkera.

GBP to USD exchange rate

A spike was detected in GBP/USD and other Sterling pairs when Barnier's Irish border comments hit the newswires.

Barnier's comments were soon followed up by comments from Ireland's Prime Minister Leo Varadkar.

Varadkar has said there are a few ways to avoid a hard border and if there are proposals that genuinely finds a solution, he will listen to them.

However, if there are no meaningful suggestions, "we cannot move away from backstop," Varadkar told broadcaster RTE

He adds that if there is a no-deal Brexit outcome, it will be the choice of the UK government.

The tone from Varadkar and Barnier - two central figures from the EU side - suggest there is some willingness for movement on the key issue of the backstop.

Therefore, the prospect of a negotiated settlement remains alive and there is a risk that markets feel they have oversold the Pound as a result.

However we would not expect any resolution to come without a good dose of political drama. Indeed, we have seen that even when the EU do offer more concessions it does not necessarily translate into the deal being passed by Parliament.

Weeks of intense political negotiations on both sides of the English Channel lies ahead, and Sterling should retain a nervous undertone as a result.

"GBP is clearly vulnerable against a backdrop of political uncertainty and a deteriorating UK economic environment," says Jane Foley, a foreign exchange strategist with Rabobank. "The Brexit outcome and politics developments remain the largest driving factor for GBP." Rabobank are forecasting the GBP/EUR exchange rate to be at 1.11 in three months, but a resolution to the ongoing chronic political uncertainty should see Sterling to recover with the exchange rate forecast at 1.16 in six months.

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