British Pound to Advance on Euro Over Coming Weeks: TD Securities, MUFG

James Rossiter TD Securities

Above: James Rossiter, TD Securities. (C) TD Securities.

Foreign exchange analysts at TD Securities and MUFG tell clients the conditions are now in place for the Pound to rise against the Euro.

The British Pound might be entering a phase of appreciation, according to foreign exchange analysts, with one strategist at TD Securities suggesting that trading GBP/EUR on the options market could result in profit.

Meanwhile, Derek Halpenny at MUFG says the prospect for gains against the Dollar should also not be discounted, as Sterling is likely to rise across the board.

Behind renewed expectations for Sterling strength are political developments on Brexit, which confirm the U.K. and E.U. are finally making some progress towards the commencement of all-important trade talks.

“All else equal, a formal confirmation of a payment agreement reduces some of Sterling’s Brexit risk premium,” says James Rossiter, a strategist at TD Securities.

The Bank of England flagged the increased risk premium attached to the Pound and other U.K. assets in its latest financial stability report, which reveals itself by the discount attached to U.K. assets relative to comparable peers in other markets.

“News that the E.U. and the U.K. have reached a deal on the financial settlement is very significant. In spite of recent concerns over the Irish border issue, this is the most important development pointing to a likely deal,” says Derek Halpenny, European head of global markets research at MUFG.

However, if the residual problems of the Irish border and citizens rights are resolved in good time, it could mean there is more upside to be had this side of New Year - which could compress the risk premium attached to the Pound even more.

Indeed, reports on Thursday, November 20 suggest fresh proposals from the U.K. concerning the Irish border might just be enough to allow the E.U. 27 to green light trade talks, starting as early as January 2018.

The Pound has risen in response.

“We continue see a considerable degree of two-way risk for Sterling. Political wrangling over the agreement’s ultimate size aside, the ability for both sides to move on to the next phase of discussions allows for some cautious near-term optimism to build in GBP,” says Rossiter.

This week's breakthrough on the financial settlement comes after the UK government  agreed a methodology to calculate the so called “Brexit bill”, which could result in payments worth close to €100 billion in total and €55 billion after adjustments and deductions are taken into account.

“We do not want to take this too far, however, as a host of thorny issues remain—many of which cannot be resolved simply by throwing money at them,” Rossiter warns.

Markets now appear to expect the European Council to vote at its December 14 summit to allow Brussels negotiators to begin discussions about future trade relations and a transition period.

“The likelihood is that the E.U. and the U.K. will agree to some form of carefully crafted written agreement that will provide the guarantees required by the Irish government in order to ensure its veto is not used,” says Halpenny.

“This combination keeps us on a highly tactical footing with respect to the Pound. Indeed, we see opportunities emerging for GBP on both sides for the foreseeable future. Our current positioning reflects this,” adds TD Securities' Rossiter.  

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Economy Not that Bad

The UK economy picked up a touch in the third-quarter and, despite a series of gloomy forecasts for the future from the likes of the Office for Budgetary Responsibility and the OECD, it is argued in some corners that there is a risk markets become too negative on the U.K.

The OECD predicts real GDP growth will slow from 1.5% this year to 1.2% next year and 1.1% in 2019.

“But with FX-induced inflation set to fade, with growing evidence of wage growth picking up, with the euro-zone economy near-on booming and with a transition period of two-years now about to be confirmed, we struggle to see why the economy will slow as the OCED forecasts,” says MUFG’s Halpenny, laying out his pro-Sterling position.

Betting the Pound will Rise Against the Euro

Conditions are therefore ripe for some recovery in Sterling as Brexit risk premium is reduced and the Pound recovers to fairer valuations linked with a steady economy.

Firmer economic indicators and falling inflation could mean the economy regains some more of its lost momentum once into the New Year, something which might see interest rate derivatives and bond markets more willing to price in an additional rate hike from the Bank of England in the near future.

“We like GBP on a valuation basis and think it could recover smartly if the shroud of Brexit uncertainty is lifted,” says Rossiter.

The TD Securities team recommend avoiding spot foreign exchange (cash) trades in the coming weeks and say, instead, investors should use options to try to profit from forthcoming events.

“With a possible US tax deal on the immediate horizon, we prefer to avoid GBP/USD as a vehicle to express potential GBP upside. This leaves EUR/GBP as the other primary alternative,” Rossiter says.

The trade recommended by TD Securities is complex but it makes money when the Pound-to-Euro exchange rate rises above the 1.1450 level, implying an expectation on the TD Securities team that the rate could go to at least this level.

Also seeing gains in Sterling, but this time also against the Dollar, is MUFG's Halpenny:

“Our year-end GBP/USD target of 1.3600-1.3700 is clearly achievable. Furthermore, levels over 1.4000 next year are also achievable based on actual economic growth being stronger than the building consensus of economic weakness in the coming years.”

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Strong Week for Sterling as Brexit Blocks Fall into Place

The British Pound has moved higher into the start of the new month amidst reports of further progress on outstanding issues in the first stage of Brexit negotiations are met by renewed buying interest.

Markets bid the Pound to fresh tw-month highs against the Dollar and multi-week highs against the Euro on Thursday, November 30 on reports that the question of the Irish border appears to have been dealt with to an extent which will allow Brexit talks to progress to the next stage.

The Times reports British officials tabled proposals this week to avoid a hard-border in Ireland that could unblock the last remaining major obstacle to a deal.

The Pound will have liked the observation that "EU leaders are preparing to offer a two-year Brexit transition deal as early as January after negotiators said that they were close to a breakthrough over the Northern Ireland border."

"GBP soared after the Times reported that negotiators are close to a breakthrough on the difficult problem of the Irish border. If the two sides agree, E.U. leaders reportedly could offer Britain a two-year transition arrangement as early as January. The news triggered a lot of stops that pushed the currency higher. This would be tremendously bullish for Sterling," says Marshall Gittler at ACLS Global.

“After sufficient progress on withdrawal we will open the next two phases of negotiations, first of all on a transition period and then on the future partnership,” a senior EU negotiator told the Times. “A transition deal will be ready in principle for January.”

Progress on the Irish border follows news that both the U.K. and E.U. had arrived at a figure that would settle the U.K's outstanding financial liabilities once it leaves the Union.

The two sets of news have allowed the Pound-to-Euro exchange rate to advance towards 1.1368 which represents the top of its September-November range.

Looking at the market from the other direction, the Euro now buys less than £0.88; a key technical breakdown:

The Pound-to-Dollar exchange rate is meanwhile seen at 1.3466 - a two-month high.

The news comes as analysts maintain the Pound's outlook remains intimately linked to progress on Brexit.

"Greater clarity around Brexit arrangements as 2018 progresses should boost wavering business confidence, employment and investment. Given that uncertainty has been the biggest driver of GBP weakness, a rise in certainty may well support sterling," says Giulia Specchia at ANZ.

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