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Pound Sterling Hits November Lows vs. Euro as EU Looks to Shut Doors on UK Services Sector

Tusk to set out Brexit trading stance

Above: Michel Barnier, Donald Tusk © European Council

Pound-to-Euro exchange rate down to 1.1156 as Europe looks to refuse the UK's service sector unfettered access to the continent, and more losses for Sterling are likely we are told.

The Pound fell to its lowest level against the Euro since November 28 2017 during the mid-week session as the European Union reveals it is seeking a Brexit trade agreement involving no tariffs on goods, close cooperation on defence, security and policing but a limited services agreement.

This suits the strengths of the EU which enjoys a surplus in the trade of goods with the UK while disadvantaging the UK which enjoys a surplus in the trade of services with the EU.

EU Council President Donald Tusk laid out the plans in a speech in Luxembourg with the aims of offering further details on the EU's negotiating position on Brexit.

The UK's financial services sector therefore looks set to be a big loser of the EU's position, should the UK fail to negotiate a better deal.

Tusk's latest intervention is just the latest in a series of moves either side of the channel aimed at agreeing a deal on the Brexit transitional period at the March 22-23 European Council summit.

"The gulf remains significant, it would seem. We continue to see Brexit as a significant risk for the GBP in the near-to-medium term," says Shaun Osborne, a foreign exchange strategist with Scotiabank in Toronto.

Markets are clearly nervous about the prospects of a deal being reached having noted that the European Union is unlikely to cede to the UK's negotiating stance, which could ultimately see the trading relationship between both sides revert to WTO rules in March 2019.

Details of the statement released by the European Council show a free trade agreement is as ambitous an agreement Europe is willing to reach for saying divergence in external tariffs and internal rules necessitates checks and controls at the border which will create frictions in trade.

A summary of the draft guidelines shows:

  1. The EU wants tariff-free and quota-free trade for goods
  2. There can be no“partial participation” in the single market for the UK
  3. Services will be included in the deal but with restrictions
  4. EU is ready to change its position if the UK rubs out its red lines
  5. EU wants close cooperation on defense, security and policing
  6. Bloc wants to maintain existing reciprocal access to fishing waters and resources
  7. EU wants deal on aviation to ensure continued connections
  8. EU seeks mutual recognition for professional qualifications

With the UK looking unwilling to back down on the single market and customs union the shape of the deal to come is starting to emerge. Clearly, Sterling's reaction suggests traders aren't too enthusiastic.

Concerning the outlook for Sterling in the wake of recent developments, technical analyst Karen Jones with Commerzbank says the Euro is holding at the top of its five month channel against the Pound which suggests a break higher is imminent.

Jones believes the Euro could push higher to the October 2017 high, which translates into the October 2017 low in the Pound-to-Euro exchange rate located at 1.1070.

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Markets are bidding the Euro higher in confirmation that they reckon the directionality posited by Jones is correct as they do not see Tusk as offering any help to Sterling.

"UK red lines will determine shape of our future relationship," Tusk said on March 1 when announcing today's release of draft guidelines. "Let’s be clear: there can be no frictionless trade outside the customs union and Single Market. Friction is an inevitable side effect of Brexit. By nature."

Tusk draws focus to the UK's red lines but does not allude to the EU's red lines which are apparently so entrenched they are not worth mentioning; the room for compromise appears limited.

Analyst Dominic Bunning at HSBC meanwhile confirms to clients that his bank is forecasting a lower GBP/EUR exchange rate over coming months, warning that UK political pressures are simply not going to ease enough to allow Sterling a fresh shot at making a sustainable recovery against the Euro.

"GBP is facing renewed political pressure and it is difficult to see how this pressure eases," says Bunning, a strategist at HSBC's London headquarters.

Concerning ongoing Brexit negotiations Bunning notes "there still appears to be a wide divergence of views between the various players involved" and the UK must provide real detail "to make policy workable and enforceable and to give businesses time to plan their strategies."

HSBC believe there appears to be little reason to be constructive on GBP from a political angle.

The Euro-to-Pound exchange rate is forecast to rise to 0.93 this year, which gives us a Pound-to-Euro exchange rate target at 1.0750; in line with a similar forecast established by peers at Deutsche Bank.

One of the UK's oldest private foreign exchange brokers has this week warned that the recent deterioration in the Pound-To-Euro exchange rate is likely to give way to a significant deterioration.

"The corrective structure of previous Sterling gains suggests further deterioration going forward," says Lucy Lillicrap a technical analyst with AFEX.

AFEX was founded in 1979 and exchanges currency for private individuals and corporates while also mitigating foreign exchange related risks for clients.

Lillicrap's suggestion that a deterioration is increasingly likely represents a shift away from a previously bullish stance.

Last week the analyst wrote of GBP/EUR that "more recent consolidation could of course also be used as a base/platform from which to enable fresh GBP gains over coming weeks."

The Pound now buys 1.12 Euros on the inter-bank market, where it bought as much as 1.15 on January 25, a deterioration that suggests momentum now lies with the Euro.

"Indeed at some point this macro bearish cycle is likely to force prices to new historic lows again," warns Lillicrap. "Values have also only recently failed to establish themselves back above the psychological 1.1500 level."

The analyst warns, "if psychological support at 1.1000 now fails to contain re-emergent GBP weakness prior action (since October) can be used as a top from which to attack previous 1.0750 lows more or less directly."

 

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