British Pound: Johnson Doubles Down on Brexit Message, Euro Sent Sharply Lower by ECB

Johnson in parliament

- Johnson in first appearance before MPs

- Sterling outlook to remain clouded as EU and UK head for clash on Brexit deal

- Euro exchange rates sent sharply lower by ECB policy event

Prime Minister Boris Johnson today set himself on a collision course with Brussels after he told Parliament he would be seeking a fundamentally new deal.

In his first appearance in the House of Commons as Prime Minister, Johnson said that the Northern Irish backstop has to be scrapped altogether, and that time limit or exit mechanism not enough.

Asked why he thought the EU would even consider renegotiating - when they have clearly stated they would not - Johnson says he believes compromises must ultimately be found if a 'no deal' is to be avoided.

"Why begin by assuming that our EU friends will not wish to compromise? I think they have every reason to want to compromise, and that is what we will seek," said Johnson.

The European Union has repeatedly said it will not consider opening up the Withdrawal Agreement to renegotiation, and that the backstop would stay intact.

The clash between the two sides will surely only raise expectations for a 'no deal' Brexit, something that Johnson also told MPs he stands ready to deliver.

Pound Sterling has been in recovery mode over recent days and has hit fresh July highs against the Euro during the course of the past 24 hours, there are however concerns as to whether the rally is able to extend too much further amidst chronic political uncertainty.

Pound bounces

We note that the gains are more technical in nature and are therefore cautious in attributing the rise in value of Sterling to the market welcoming Johnson's rise to Prime Minister.

"We do not see a strong fundamental reason why recent Pound gains should be sustained at this stage," says Lee Hardman, a currency analyst at MUFG.

That Johnson would become Prime Minister has been well known to markets for some time and we believe it is what comes next that counts; specifically what comes next regarding Brexit developments and whether or not the Government would be brought down in a no-confidence vote.

Johnson stressed to parliament his “absolute commitment” to leaving the EU on October 31 and said he would “turbo-charge” preparations for a no-deal divorce as he set out his priorities for government. Earlier he chaired the first meeting of his new cabinet.

Johnson also said he has instructed his Cabinet to ramp up preparations for leaving the European Union, telling the House of Commons he’s instructed Chancellor of the Exchequer Sajid Javid to make available “all necessary funding.”

Johnson did however repeat a line that he does not believe a 'no deal' will be the eventual outcome: on the leadership campaign trail he said he did not believe for one second a 'no deal' Brexit would take place.

Despite Johnson's optimism that a negotiated solution will be found markets will likely stay cautious, and Sterling should remain trading at a deep discount against other major currencies as a result.

"Brexit uncertainty and “No Deal” fears are both set to remain elevated remaining heavy weights on the Pound. New PM Boris Johnson has clearly reiterated that the first aim of his government will be to leave the EU at the end of October with or without a deal. The composition of the new cabinet appears consistent with that aim," says MUFG's Hardman.

The selection by Johnson of a decisively pro-Brexit cabinet has raised the prospect of a General Election according to a noted currency analyst we follow, and this should keep enthusiasm towards Sterling muted.

Johnson included Priti Patel as Home Secretary, and Jacob Rees-Mogg as Leader of the House of Commons.

Noted Brexiteer Dominic Raab heads up the defence brief. Brexiteers have also come in lower down the Cabinet pecking order with Esther McVey taking the brief of Minister of State at the Ministry of Housing and Local Government.

"The three main options for Brexit over the next three months are: (i) a new Withdrawal Agreement between the UK and EU; (ii) a hard Brexit; or (iii) an extension of the 31 October deadline triggered by new general elections or another referendum. In the meantime, Brexit‑related uncertainties will remain a drag for GBP," says Elias Haddad, a strategist with CBA.

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Euro Hit by ECB Statement

The Pound's rally against the Euro has potentially more to do with a sharp turn lower in the Euro than it does with Pound strength.

The Euro was sent reeling on Thursday following the European Central Bank's monthly policy event that saw policy-makers strike a decidedly 'dovish' tone. The sinking Euro allowed the Pound-to-Euro exchange rate to climb up to fresh multi-week highs at 1.1242.

No major changes were made to the ECB's policy settings concerning interest rates and quantitative easing, however the statement that followed the meeting was noted to be more 'dovish' than expected.

In short, the ECB made clear to the markets notable action was coming as it tries to boost economic growth.

The ECB said interest rates would stay at current levels or go lower, while it said it would pursue tiered deposit rates and consider new asset purchases.

The ECB's strong message that action comes as data released on Wednesday and Thursday shows Germany's economy is slowing dramatically, and could sink into recession in the third quarter of 2019.

"As if it wasn't hot enough already in the eurozone today, expectations about today’s ECB meeting also raised the temperature levels. The ECB refrained from cutting rates or new monetary stimulus but are clearly preparing markets for a rate cut and probably even more at the September meeting," says Carsten Brzeski, Chief Economist with ING Germany.

"It now increasingly looks as if the September meeting will not only bring a single measure but rather a package of several measures," adds Brzeski.

When central banks cut interest rates, or print money and buy assets through a quantitative easing programme, the currency they issue tends to fall in value.

The mechanics behind why a currency would fall are actually quite simple: if you increase the supply of a good, all being equal, then the value of that good falls. By pumping more Euros into the Eurozone, the Euro is understandably being devalued.

Just ask U.S. President President Donald Trump, who said back in June: "Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA. They have been getting away with this for years, along with China and others."

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