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BofAML 'Constructive' on Sterling vs. Euro and Dollar in 2019

DUP Arlene Foster

Above: The DUP's Arlene Foster has rejected a proposal giving parliament more scrutiny over the backstop clause. Image © DUP, Reproduced Under CC Licensing

- DUP stance unwavering ahead of key Brexit vote

- Bank of America see value in Sterling

- 2019 to see Sterling advance on Euro, Dollar say analysts

Despite the legislative impasse holding back a Brexit deal, Pound Sterling continues to show a resilience, suggesting markets are yet to panic and the market-unfriendly 'no deal' will be avoided.

New analysis from Bank of America Merrill Lynch shows the Pound could rise by almost 8% against the Dollar before the UK leaves the European Union with analysts saying the currency offers investors a unique opportunity for investors. 

An anticipated decline of the U.S. Dollar, which is expected to suffer over coming months as 2018's tax cuts wear off and tensions between the White House and Beijing simmer, will contribute to the recovery. 

But the forecast largely rests on an assumption the UK avoids an exit from the EU on World Trade Organization terms. 

The UK's pending exit from the EU has left Sterling trading at a discount to where analysts say it should be as markets have already felt compelled to bake a significant amount of future economic underperformance into exchange rates. 

That will provide the currency with at least some immunity from other risks in the market during what the Bank of America team says could be a volatile year for financial assets.

"Brexit continues to provide the most idiosyncratic risk in G10, which means our view on GBP is effectively insulated from our broader Year Ahead themes. Our constructive view on GBP over the coming months is premised on three factors," says Kamal Sharma, a currency strategist at Bank of America.

Sharma and the Bank of America team assume Prime Minister Theresa May will eventually get her Withdrawal Agreement passed through parliament, which will close the door on any possibility of a widely maligned exit from the EU on WTO terms - for a period of time at least.

That is expected to enable markets to go back to basics and begin thinking about the Bank of England (BoE) and the scope it might have to raise interest rates in the future.

The BoE has provided clear hints it would like to raise interest rates at least once every year for the foreseeable future, although this is not yet reflected in exchange rates. 

Changes in rates, although normally only made in response to movements in inflation, have an impact on currencies because of the influence they have over capital flows and their allure for speculators. 

"We think there is likely to be a material repricing of the UK rates curve once a deal is announced and ratified, which in turn is likely to be bullish for GBP," the strategist says. 

Traders have been readying themselves for a seemingly inevitable defeat of the government when the House of Commons gets its "meaningful vote" on the Withdrawal Agreement on Tuesday 11, December.

Lawmakers on all sides of the House of Commons have pledged to vote against the proposals for a variety of reasons and the PM is currently expected to lose the ballot in the Commons.

Approval before March 29, 2019 is key if the UK is to avoid leaving the EU without any preferable arrangements in March 2019 and defaulting to trading with the bloc on World Trade Organization terms. 

Sharma notes the increasing possibility that the House of Commons might reject Prime Minister Theresa May's Withdrawal Agreement but is undeterred by it. 

"This inevitably leads to a knee-jerk sell-off in GBP, but we do not think that this makes no-deal the default alternative nor does it pose existential risks to GBP," he writes, in Bank of America's year-ahead outlook. "We think any of the alternatives will necessitate that the UK stay within the EU for a longer period either via an extension of Article 50 or via a second referendum." 

Sharma and the Bank of America team forecast the Pound will rise to 1.36 against the Dollar before year-end and that it will climb further, to 1.38, by the time the UK technically departs the EU on March 29, 2019. That is an increase of almost eight percent from Thursday's 1.2790 level.

The Pound-to-Euro rate is projected to rise from 1.12 to 1.15 before year-end and to remain close to that level throughout 2019, before ending next year at 1.16. That is only a modest increase from current levels, which is due largely to the bank's anticipation that the Euro will also rise against a weakening Dollar over the same time period. 

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DUP Won't Budge Despite Latest Plan to Make Brexit Deal More Palatable

The British Pound is paralysed with investors not willing to take bets on the currency in either direction thanks to an ongoing chronic uncertainty as to how the Brexit process will unravel over coming days.

Expectations for Theresa May's Brexit deal to be rejected were further entrenched late Thursday on news the DUP would reject any late ammendment to the Brexit deal that would give parliament a more prominent role in deciding whether the Northern Ireland backstop should be enforced in the event of trade negotiations failing.

Recall, the government requires the DUP to vote with the Conservative party in order to pass any legislation.

The certainty that the deal will fail in its current format only begets further uncertainty as a number of scenarios are kept alive ensuring traders lack conviction in pushin the Pound higher or lower.

Sterling looks set to close the week more-or-less where it started with remarkably little change in the key Sterling exchange rates being seen since over the past five days.

At the time of writing a marginal loss is seen against the Euro and a marginal gain against the Dollar with the majority of moves against the G10 coming in below 0.10%.

There were hopes that a new ammendment to the Brexit legislation - floated by Conservative Party MPs sympathetic to the government late on Thursday - would help sway opponents into backing the deal and minimising the scale of loss suffered next week.

The proposed ammendment sought to give parliament more say over whether a controversial backstop clause in the Withdrawal Agreement is ever triggered. The backstop clause is fiercely opposed by Conservative Party backbenchers and Northern Ireland's DUP whom the government relies on to get legislation passed through the House of Commons.

The government hoped the proposed ammendment would whittle down opposition to manageable levels. However, the DUP immediately rejected the proposal because it offers nothing more than a mere "tinkering".

"Domestic legislative tinkering won't cut it. The legally binding international Withdrawal Treaty would remain fundamentally flawed as evidenced by the Attorney General," says DUP leader Arlene Foster.

Foster wants the treaty renegotiated. Sir Graham Brady, who represents backbench Conservative party MPs, says that next week’s meeting of the European Council offers an opportunity for May to wring further concessions from the EU.

“I can’t see why there should be an objection to providing either an end date - three years’ time, whatever it might be - when we would automatically leave that arrangement or some other mechanism just to make sure we could leave," Brady says, hinting at the concession that will get a deal done.

The European Union have however stressed the Withdrawal Agreement is not open to renegotiation.

"If necessary, the EU meets next Thursday and Friday and could tweak the offer somewhat, but I doubt if they will make big enough changes at this point to get it to pass as is. It’s still a dangerous situation. Althoug generally speaking in past crises the EU has managed to pull off some compromise at the last minute," says Marshall Gittler, a strategist with ACLS Global.

"I’m still cautious about sterling," adds the strategist.

The Telegraph reports Friday that Chief Whip Julian Smith has informed Prime Minister Theresa May she is still short of as many as 200 votes ahead of next Tuesday's parliamentary showdown.  

For Sterling, the scale of the loss is important because only a small defeat would signal to markets that the government's deal could pass through parliament on a second attempt provided further ammendments are made.

A large loss would signal that the Brexit deal is dead while sharply increasing the odds of a potentially market-damaging 'no deal' exit in March 2019.

A 'no deal' Brexit is therefore possible - even if some in the market believe it has actually reduced over recent days - and angst over this could keep the Pound under pressure over coming days and weeks.

Sterling retains a soft underbelly with 1 GBP buying 1.1211 EUR on the interbank markets, high-street banks are seen offering exchange rates in the 1.09-1.10 bracket for international payments, independent providers are offering rates in the 1.11-1.1120 bracket.

1 GBP buys 1.2757 USD, banks are offering rates in the 1.24-1.25 region, independents in the 1.2640-1.2660 region.

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