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Sell British Pound, Buy Euro as Market is Only Now Waking up to Brexit Risks say JP Morgan

- GBP/EUR is a better vehicle than GBP/USD to profit on declines

- Declining European political risks bode for a stronger Euro say JP Morgan

- But Danske Bank say buy Sterling weakness - a strategy that has this week proved correct.

JP Morgan strategy

The Chase Tower, New York © Kristen Cavanaugh, Flickr. Reproduced under CC licensing.

The Pound is set for renewed losses against the Euro and safe-haven Swiss Franc, according to strategists at J.P. Morgan, who argue in their latest research that clients of the bank should now bet against the British currency.

The J.P. Morgan team decided last week to maintain bearish bets against the Pound-to-Dollar exchange rate and the Pound-to-Yen exchange rate following the pivot by an additional Bank of England rate setter toward supporting another interest rate rise, given expectations that markets would soon renew their focus on an absence of progress in the Brexit negotiations.

Accordingly, Friday brought talks between the UK and EU back into sharp focus and the J.P Morgan team are adapting their trading strategy as a result.

"Short GBP positions have started to perform in the last couple of days as the market seems finally to be acknowledging the reality of a Brexit process that is effectively stalled," says Paul Meggyesi, vice president of currencies and commodities at J.P. Morgan. "The reduction in Eurocentric political risk combined with the improvement in the continental data flow warrants rotating cash positions in GBP from JPY and USD into EUR/GBP and GBP/CHF."

The European Council warned last week the European Union will step up its preparations for a UK exit from the EU without any agreement on the future relationship given an absence of progress in talks, while indicating there is scope for flexibility in agreeing a post-Brexit trade deal if the UK is willing to accept the supremacy of the European Court of Justice in some areas of UK law.

The Pound just ended its worst quarter of trade against the Dollar since the Brexit vote, having fallen more than six percent since April to a 7-1/2 month low. Sterling had meanwhile maintained a broadly stable sideways-orientated trend against the Euro until a recent decline took it down through the bottom of the range at 1.13, suggesting the door could be opening to a more sustained move lower.

For Sterling's near-term prospects, much will depend on this week's Brexit developments.

On Friday Prime Minister Theresa May is expected to push her cabinet for an unified stance towards the future EU-UK trading relationship with a specific focus on the nature of the customs relationship.

"The next potential Brexit flashpoint focus will be the cabinet meeting on Friday at which the PM will once again attempt to hammer out a common government position on customs policy, the single market, and associated Brexit red-lines," Meggyesi adds, eyeing the week's cabinet meeting as a potential precursor to renewed fears over a challenge to PM May's leadership.

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The meeting will be followed by the publication of an official White Paper for markets and EU negotiators to sink their teeth into. If deemed to be credible and somehow soothe concerns of Brexiteers, Remainers and the EU, then Sterling could well find itself in a much happier position.

Indeed, analysis by Pantheon Macroeconomics suggests May is ultimately on a path to a soft Brexit, and the benefits to Sterling of such a decision are notable. Economists at the independent research house say GBP/EUR can go as high as 1.27 by the end of 2019 and GBP/USD could go as high as 1.40 by the end of 2019 on a soft Brexit.

Fears are that without further concessions from Downing Street the UK will be on course for a "no deal" Brexit, which will almost certainly lead to tariffs and so called non-tariff barriers being raised between the UK and EU, which many say would dent economic growth and deal another blow to Pound Sterling.

However with too many concessions the government, which is bitterly divided over the EU, could fall if there is a sizeable rebellion amongst lawmakers who want the purest of Brexits. This would mean another election that may bring the opposition Labour Party into power, which some say would also be bad for the economy given its socialist leanings and past track record as far as the nation's finances are concerned.   

The apparent lose-lose situation May finds herself in leads J.P Morgan strategists to anticipate the Pound-to-Euro exchange rate is particularly exposed to a move lower.

The Pound-Swiss Franc exchange rate is down 0.46% in 2018 having reached 1.3051 but a deeper fall is anticipated during the months ahead.

Elsewhere, Netherlands-based Rabobank cut their forecasts for the Pound-to-Euro rate just last week.

"In light of the sheer degree of political risk it is surprising that volatility in the pound has not been higher in  recent weeks," says Jane Foley, an FX strategist at Rabobank, a multi-national financial services provider.

Foley and the Rabobank team now forecast the Pound-to-Euro rate will rise to only 1.15 this year, given uncertainty over the trajectory of the Brexit talks, down from 1.19 previously.

But this reduced forecast still implies some upside for the Pound during the months ahead, which chimes with the Danske Bank strategy on GBP/EUR which seeks to buy any weakness in Sterling.

And, judging by the bounce back from three-month lows witnessed over recent days, this strategy is indeed playing out as a profitable one.

"The UK governments discussions around its white paper is likely to attract more attention when Theresa May’s cabinet most likely meets next week to try to come to an agreement. From a risk/reward perspective, we think the break above 0.8850 in EUR/GBP is a selling opportunity," says Vladimir Miklashevsky, a trading desk strategist at Danske Bank.

O.8850 in EUR/GBP translates into buying below 1.13 in GBP/EUR terms.

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