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Pound-Euro Week Ahead: On a Knife-edge as Market Hopes for Brexit Climbdown, BoE Looms

-GBP/EUR looks to stabilise with ‘no deal’ near-50% priced.
-Amid talk of negotiating tactics, ahead of Oct bill deadline.
-But technical damage is done, GBP risks more GBP losses.
-Brexit talks and BoE loom as analysts differ on GBP outlook.

© Andrew Parsons/ i-Images, Flickr, Reproduced under CC Agreement. File image of Prime Minister Boris Johnson. Picture by Andrew Parsons / No 10 Downing Street

  • GBP/EUR spot rate at time of writing: 1.0799
  • Bank transfer rate (indicative guide): 1.0523-1.0599
  • FX specialist providers (indicative guide): 1.0639-1.0704
  • More information on FX specialist rates here

The Pound-to-Euro exchange rate could look to stabilise while balanced on a knife-edge over the coming days after its worst week since March, although the British currency has sustained technical damage on the charts and there’s a risk that it suffers more punishing losses before any eventual, meaningful recovery.

Pound Sterling fell close to four percent against the Euro after the government sought through its Internal Market Bill, a mechanism through which it could ‘clarify,’ override or disapply terms of the EU Withdrawal Agreement.

Johnson's gambit will in the government's own words, "breach international law," but is intended only as “a legal safety net designed to protect our country against extreme or irrational interpretations” of the new EU treaty after Brussel's interpretation of it alarmed London.

It has drawn European threats of a trade war, legal action and what might then be an inevitable end to the Brexit trade talks. 

"It has been made clear to us in the current talks that there is no guarantee of listing us. I am afraid it has also been said to us explicitly in these talks that if we are not listed we will not be able to move food to Northern Ireland. The EU's position is that listing is needed for Great Britain only, not Northern Ireland. So if GB were not listed, it would be automatically illegal for NI to import food products from GB," says David Frost, EU adviser to the Prime Minister and British trade negotiator. "I hope the EU will yet think better of this."

A 'no deal' Brexit could now be more likely than ever before and partly due to significant flaws in the EU withdrawal agreement as well as its accompanying political declaration, which readers can get more on here.  

Above: Pound-to-Euro rate at 4-hour intervals with S&P 500 futures (blue line, left axis).

Brexit will again feature as the dominant consideration for Sterling traders this week, although the enhanced risk of a 'no deal' exit from the transition period could mean the Pound again lags other major currencies during any broader bouts of risk aversion seen over the coming days.

Last week’s losses took the Pound-to-Euro rate through and below an important layer of Fibonacci support on the charts, opening the door to even further declines, although some analysts have suggested that clients take profits on bets against the British currency.

While not enough to rule out further losses, the sheer scale of Sterling’s earlier decline and the sway held by hope over financial market psychology could mean the Pound-to-Euro exchange rate seeks to stabilise over the coming days, although it would be doing so while balanced on a knife edge. 

“We still see a 30% chance of a deal. But the current conflict makes it even more difficult for the EU to soften its position on contentious state-aid, fisheries and dispute settlement issues. In addition, the EU may be less willing to agree to many stopgap measures to soften the blow of a hard exit on 31 December. As a result, the “semi-managed” hard exit – which is our base case with a 50% probability – may be less managed and more disruptive in early 2021,” says Holger Schmieding, chief economist at Berenberg. “The chaos in London makes the option of leaving the club look even more unattractive. For the EU, which would like to preserve close relations with its neighbour across the Channel, this would be no more than a small consolation, though.”

Above: Pound-to-Euro rate at daily intervals with Fibonacci retracements of March-to-September recovery.

Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank sold the Pound-to-Euro rate at 1.1188 and again at 1.1235 but has suggested that Commerzbank clients should take profits off the table after Sterling fell back to 1.08 last week.

But they've also advocated that clients sell the Pound-to-Euro again upon a rebound to the 1.09-to-1.0989 area and look for a subsequent fall to around 1.0726.

Goldman Sachs meanwhile have targets for the Pound-Euro exchange rate set at 1.15 for their 'base case' expectation that a deal is reached between the EU and UK but they have a target set at 1.00 for a disorderly "no deal" exit.

 

 

"Based on those estimates, the market is currently pricing a 40-45% chance of the "no deal" outcome. We have low confidence on how the debate around the legislation will evolve in the coming days, and those odds could rise further if the attempted Tory rebellion fizzles out. But beyond the very short-term we would see meaningfully lower odds of a "no deal" Brexit than the market appears to be implying,”says Zach Pandl, global co-head of foreign exchange strategy at Goldman Sachs. “For investors willing to look through some near-term volatility, current levels for Sterling longs now look attractive, in our view.”

Asset prices and exchange rates rarely go anywhere in an entirely linear fashion, or straight line, and Prime Minister Boris Johnson still has more than two weeks left on the clock to amend or abandon the offending Internal Market Bill before the point when the EU says it’ll abandon trade talks with the UK. 

This means that even if a now-more-likely 'no deal' Brexit justifies even lower levels for Sterling, the Pound-to-Euro rate might still attempt to stabilise over the coming days, which could be even more the case now that Prime Minister Johnson has alluded to the whole thing being a negotiating tactic. 

Johnson said "Let’s make the EU take their threats off the table. And let’s get this Bill through, back up our negotiators, and protect our country," via Twitter on Saturday, echoing a statement to parliament made on Friday. 

Above: Pound-to-Euro rate at weekly intervals with 200-week moving-average in black.

“Despite its profound fall in the past few days, we expect the pressure on GBP to continue building next week as until-recently complacent investors adjust to the new reality of a heightened no-deal Brexit risk and start/continue building GBP shorts,” says Petr Krpata, CFA and chief EMEA strategist for currencies and bonds at ING. “With EUR/USD likely to remain range-bound (and hence giving limited support to GBP/USD), expect GBP/USD to head towards 1.2500 next week (and EUR/GBP to 0.9500).”

Krpata looks for Sterling to resume declines before the week is out and to head toward 1.0526, at which point the elevated threat of a ‘no deal’ exit will be largely in the price of Sterling, and has told clients that this weeks Bank of England (BoE) interest rate decision should have little bearing on exchange rates.

These levels however, would only be available on the interbank market, and the unfortunate reality for retail customers who've a real world need for Euros is that high street banks are already quoting Pound-to-Euro rates as low as 1.05. Specialist international payments firms can help to mitigate the effect of recent and future falls in Sterling

The BoE will announce its latest decision at 12:00 Thursday and consensus is looking for Bank Rate to be left at 0.10% and for the quantitative easing programme target to be left unchanged at £745bn. Many in the market anticipate that the BoE will not act to support the economy again until November, after the next budget. 

“The UK faces a trifecta of risks: a surge in virus infections and tightened social distancing rules, a Brexit without a trade agreement and an imminent rise in unemployment. Third quarter GDP growth will be record breaking, but the recovery going forwards will be limited by these significant uncertainties,” says Stefan Koopman, a senior economist at Rabobank. “We continue to view the balance sheet as the policy instrument of choice, but the slowdown in purchases implies that a further increase in the APF’s ceiling isn’t imminent yet.”

 


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