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- Upside potential for Sterling on breakthrough in cross-party talks
- But talks reportedly close to collapse
- Local elections pose risks in latter half of week
The British Pound opens the new week with a gain on the Euro and U.S. Dollar amidst relatively quiet action across global currency markets.
The Pound-to-Euro exchange rate is currently quoted at 1.1592, the Pound-to-Dollar exchange rate at 1.293: Both are higher than they closed the previous week but are well within the confines of recent ranges.
Domestic political headlines remain the key risk in Sterling's outlook this week with cross-party talks between the Conservatives and Labour being the initial focus ahead of Thursday's Bank of England meeting and local elections.
The British government has yet to find a way forward in talks with the opposition Labour Party on how to reach a compromise Brexit deal, Prime Minister Theresa May's spokesman said on Monday.
The spokesman said the talks would continue later on Monday with a "plenary session" due.
A breakthrough in talks poses significant upside potential to Sterling we believe as this raises the prospect of a Brexit deal finally being ratified by a deeply divided parliament.
However, market expectations for a breakthrough remain low at this juncture, hence the surprise any unexpected breakthrough would likely trigger a sizeable market reaction.
Markets are right to be wary of the talks succeeding amidst persistent media reports they nearing failure with both sides accusing each other of intransigence and time-wasting.
Labour negotiator Rebecca Long-Bailey told Sky News "I think the discussions so far have been productive, they've gone into a lot of detail, there seems to be a willingness on both sides to move towards some form of consensus.
"But as yet we haven't seen the government move on any of their red lines, we're having further discussions this week and hopefully we'll see some movement.
"But we want to see hard and fast movement on those red lines as quickly as possible."
What would happen to the Pound if this week the two sides finally 'throw in the towel'?
Because expectations for failure are already largely absorbed by the market, we wouldn't expect any major decline in Sterling should the two sides finally call an end to their endeavour.
Therefore the talks pose minimal downside risks but sizeable upside risks to the British Pound.
Political Temperatures to Rise Thursday at Local Elections
We are expecting Labour and the Conservatives to maintain talks for some time still, and would be surprised if they were called off as soon as this week.
Both sides will likely not want to take the blame for collapsing the negotiations.
Sterling is nevertheless a political currency at present, and the political temperature should rise later in the week as local elections are to be held on Thursday where the ruling Conservative Party are expected to lose up to 1000 council seats.
The loss of council seats by the Conservative Party are not typically of interest to currency markets, however because the position of Prime Minister Theresa May is so precarious at this point, the outcome of the polls will be closely watched with a heavy defeat raising questions as to how much longer she can hold onto her position.
"Local elections on Thursday will be the latest barometer of the damage to Conservative support being done by the Brexit shambles. Comparisons with the last elections in the same seats (2015) are complicated by boundary changes, but this was a high watermark for the Tory support compared to their current poll ratings and significant losses are likely," says Adam Cole, a foreign exchange analyst with RBC Capital Markets.
"The immediate implications for GBP will depend May’s prospects for surviving as PM, with imminent change (Johnson is runaway favourite to replace her) lifting political uncertainty further," says Cole.
"Local UK elections are likely to rattle the Pound," says Robert Howard, a foreign exchange analyst who sits on the currency desk at Thomson Reuters, "the Tory performance on May 2 is of prime interest."
The polical uncertainty factor however extends beyond Thursday's vote.
There are of course the European elections due on May 26 which will make for further potential politically-induced volatility as the ruling Conservatives are likely to suffer an even greater humiliation at this vote.
Current polling shows the Conservative Party will lose heavily to the Brexit Party of Nigel Farage which will likely top the poll ahead of Labour.
Latest polling by YouGov puts Farage's Brexit Party on 28%, up 5. Labour are unchanged on 22% and the Conservatives are down 4 on 13%.
Conservative MPs - as well as rank-and-file members - are incensed that the UK will have to take part in EU elections next month, something that May had previously pledged would never happen.
While the stalling of Brexit was initially viewed as being positive for the British Pound as it removed the threat of a cliff-edge, we can see how the market is less assured as to the benefits the delay has brought about.
"The extension for the Brexit date won earlier by May is not seen in a positive light by the market, because it merely raises the risks but without any commensurate opportunities. Any investor can tell you that is a bad place to be in," says Elwin de Groot, Head of Macro Strategy with Rabobank in Amsterdam.
The delay might have calmed concerns about a 'no deal' Brexit taking place in the first half of 2019, but it has only fired up domestic political uncertainty, and in this environment it is hard to see Sterling stage a substantial rally.
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