Brexit Deal Delayed but Downside Risks to the British Pound are Limited say SEB

Theresa May European Council

Above: Theresa May at a previous European Council summit. Image © European Union.

- E.U. and U.K. scrap planned November summit

- Markets think Brexit "impasse" merely political charades

- Pound-to-Euro exchange rate at 1.1386

- Pound-to-Dollar exchange rate at 1.3088

Pound Sterling was left treading water after E.U. leaders concluded not enough progress has been in negotiations to set a November summit to sign off any final deal.

However, both sides have committed to intensive negotiations in order to reach a deal with key figures saying a deal is achievable if the pace and intensity of recent negotiations is maintained.

"I believe a deal is achievable" and "considerable progress" has been made on Brexit since the last EU summit, Prime Minister Theresa told reporters.

But there is a potential for fresh domestic infighting as it appears May is mooting an extension to the two-year transition period to avoid deadlock over the Irish border.

"The real driver in the markets this morning is the news that Prime Minister May could be looking at extending the Brexit transition period by a further 12 months. To many this seems like a sensible option, why rush the negotiations whilst so many details remain? However, to many Tory Brexit MPs this may not suffice," says Hamish Muress, currency analyst at OFX.

While May did not formally propose such a move, she did reference it. This is problematic as it is unlikely there will be many in her party that would stomach an extension to the transition period that would mean the U.K. continues paying vast sums into the E.U. budget while having no say in decision making.

E.U. leaders not they "stand ready" to call a special meeting when warranted, otherwise the next E.U. summit is in December.

Despite what is clearly a disappointing summit for those Sterling bulls who would want a deal sooner rather than later, the currency continues to trade with a robust tone.

"This muted reaction shows that market players have learned the political tactics of the Brexit process," says Richard Falkenhäll, Senior Currency Strategist with SEB.

While we do expect some ups-and-downs, it will take a material piece of new information to really move Sterling; something that tells markets that either 1) talks are headed for failure or 2) a deal will definitely be delivered by year-end.

High-stake negotiations typically tend to go down to the wire, particularly when the E.U. is involved and therefore the optimism seen last week that suggested a deal would be delivered by the E.U. summit appears to have been misplaced.

"Given that there seems to be time to negotiate until December it was just too early to expect a break-through in talks this week," says Falkenhäll.

The decline in Sterling at the start of the week, which came in response to the realisation that a deal would not in fact be struck, could be Sterling simply giving back some of the misplaced gains recorded in the previous week.

Pound exchange rates might be content to trade water around current levels for some time now with markets likely to fix their gaze to either a November or December summit.

"This explains why the GBP has not sold off more despite the negative development this weekend. As long as the rift between the E.U. and the U.K. doesn’t widen further the downside risk to GBP therefore seems limited," says Falkenhäll.

Details of the scheduling of talks, and deadlines are therefore the only real material piece of information we are likely to receive from this week's summit of European leaders.

 

Pound Forecasts vs. the Euro Upgraded

SEB appear to be more confident that a deal will in fact be struck by the time the year is out and have raised their forecasts for the Pound-to-Euro exchange rate as a result.

SEB revise their one month forecast in EUR/GBP lower to 0.89 and still expect the currency pair to fall to 0.86 by year-end.

This gives a GBP/EUR upgrade to 1.1236 and 1.1628 respectively.

This comes a day after we reported analysts at the world's largest investment bank J.P. Morgan have upgraded their forecasts for Sterling-Euro for the second time in two months.

"The central scenario envisages further upside for GBP of a couple of percent on the delivery of a negotiated Brexit by 1Q19," says Paul Meggyesi, foreign exchange strategist with J.P. Morgan in London. "We are upgrading our near-term GBP forecasts by around 2% to bring them closer into line with the central scenario of a negotiated Brexit."

From a strategic point-of-view, J.P. Morgan are natural Sterling, and are forecast the Euro-to-Pound exchange rate to end the third quarter of 2019 at 0.86, down from a previous forecast of 0.87.

This gives an equivalent Pound-to-Euro exchange rate of 1.1628, up from 1.15 previously.

These forecasts appear to be higher than the consensus forecasts being held by the analyst community at present. A report - available for download here - from Horizon Currency Ltd shows just where consensus are forecasting the Pound in three, six and 12 months, drawing on targets from the likes of Citi, Goldman Sahcs, HSBC and Barclays.

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