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Fox's Turkey-Style Brexit Plan Brings Cheer to Sterling's Longer-Term Outlook

The Pound is set to rise against the Euro in 2017 with EUR/GBP falling to 0.8000 pence, from the current 0.8500, (currency pairs are always quoted in the units of the second currency in the pair), according to Xtrade’s Chief Analyst Paul Sirani.

Xtrade’s Sirani argues that the “dispersion” of forecasts for EUR/GBP, which is the widest in a decade at 0.73 – 1.00, is as a result of the unprecedented political risks in the UK and Eurozone.

“This dispersion is largely a function of today’s unprecedented political turmoil, whether you view Brexit’s tortured implementation path or the European political populism threat as the greater risk.

“Our view is that the muddle and uncertainty plaguing the British process is less threatening than the real and growing risks facing the continent, so look for sterling strengthening to some 0.8 £/€.”

Versus the Dollar he sees the Pound fairing less well as Donald Trump’s election boost the outlook for the US economy and the Dollar.

Mr. Fox Talks Turkey

The risk of a “Hard” Brexit has eased in the near term, according to analysts at Capital Economics, who argue that this may support Sterling in the short and medium term.

They say that whilst the possibility of a “Soft” Brexit option has diminished recently, the chances of a transitional Brexit buffer has increased.

The idea of a transitional deal was first raised by Brexit minister David Davis, who said that the UK could remain outside of the EU but pay for access to the common market.

This has since been adopted as a ‘transitional’ possibility whilst the niceties of Brexit are being hammered out.

Such a transitional deal would ensure the economy was not hit by a sudden Brexit as the UK would keep access to the common market.

“There are indications that the Government may be moving away from the recent “soft” Brexit rhetoric this week.

“But given the growing signs that it is also considering some sort of “transitional” arrangement for leaving the EU, this suggests that Brexit is unlikely to be both “hard” and fast,” said Capital’s UK Economist Ruth Gregory.

Recently Liam Fox floated Turkey’s model as a possible template for a UK transitional agreement.

“To recap, Turkey has tariff and quota-free trade with the EU on goods excluding agriculture, is part of the customs union and must agree to the trade agreements that the EU has negotiated with other countries.”

Turkey does not allow freedom of movement of EU citizens across its borders, however, nor does it pay nearly as much as member states into the EU budget.

However, on the downside, it cannot negotiate its own trade deals with other countries as an independent entity and must abide by the EU’s trade deals.

In addition, a Turkey-style deal would have the following drawbacks:

“The UK would have to impose common EU tariffs on goods from the rest of the world, reducing its ability to negotiate when striking new trade deals.

What’s more, this would do little to safeguard passporting rights for non-EU banks operating in the UK,” says Capital’s Gregory.

The Prime Minister Theresa May has also now discussed the possibility of an “implementation phase”, a sign it is being considered seriously by the government.  

Unlike Liam Fox, the International Trade Secretary, May declined to offer a description of what such a transitional phase might look like.

Talk of a transitional phase offering a buffer to reduce the sudden impact of Brexit has supported the pound, according to Gregory.

“Investors don’t appear overly concerned about the prospect that the pound could slide further.

“Indeed, uncertainty may have been mitigated by the discussion of a transitional agreement to avoid a potential cliff-edge once the UK leaves the EU.

“Demand for options protecting against a decline in cable remains subdued relative to levels seen around the referendum.

“And investor’s net-long positions don’t point to a further weakening,” commented Capital’s UK Economist.

Whilst Capital note this week’s strong Q3 GDP revision from 0.5% to 0.6%, closer inspection of the GDP data shows growth was almost all from domestic consumption, not trade, which will disappoint economists who had expected the weaker pound to drive growth by improving exporter’s competitiveness.

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Italian Political Risk Still on Radar

Supporting Xtrade’s earlier forecast that the Pound will rally versus the Euro is the likelihood of increasing political risk in Europe, weighing on the single currency.

Although risk fell after the Austrian Presidential election saw the far-right populist candidate lose, strategist Simon Derrick at BNY Mellon still sees political risks as threatening the Eurozone economy in 2017.

The leading anti-EU, populist party in Italy is Five Star, which also currently leads the polls, suggesting that if there was an election tomorrow they would gain a majority.

Although Five-Star would have difficulty imposing an exit or even having a referendum on an Italexit due to constitutional barriers as well as possible legal barriers, the possibility is not out of the question.

“Given the Five Star Movement’s unambiguously anti EUR stance and the global political upsets of the past 12 months, investors might decide that discretion is the better part of valour,” concludes the BNY analyst.

Indeed, this has already happened after Qatari and Chinese investors pulled out of a deal to provide 1bn in emergency funding for Italy’s oldest Bank Monte dei Paschi di Siena who were on the brink of collapse.

Journalist Nils Pratly of the Guardian saw rising political risk of an Italian exit as a major part of the reason, not just the bank’s shoddy balance sheet.

The relatively small amounts declined -  1bn is not massive by international financing terms – are a particularly bad sign for Italy as it could signal a massive fall in confidence in the country which could have a severe negative knock-on effect, not just for its banking system and the wider economy but also the whole of the EU.

 

 

 

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