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Pound Sterling Extends Lower: "Keep Calm & Stay Bearish"

Michael Gove

Above: File image of Michael Gove. Credit: Wellington College, Accessed Flickr. Licensing: Creative Commons.

- Sterling under significant selling pressure

- Market prepares for 'no deal' Brexit

- Javid to commit billions to 'no deal' Brexit planning

- Gove says increasingly unlikely EU & UK will reach a deal

Global currency markets have ramped up their own preparations for a 'no deal' Brexit on Monday, July 29 when they pushed Sterling sharply lower. The declines in the UK currency follow a slew of media reports out over the weekend that suggest an increasing probability of a 'no deal' Brexit.

Sterling is testing fresh two-year lows against the U.S. Dollar while looking heavy against other major currencies.

The Pound-to-Dollar exchange rate fell to a low of 1.2294 on Monday, levels not seen since April 2017. "Downside risks remain with interim support at 1.2300 and significant long-term support at 1.22-1.20," says Robin Wilkin, a cross-asset strategist with Lloyds Bank.

The Pound-to-Euro exchange rate meanwhile dips below the watermark 1.11 again to record a spot price of 1.1053 at the time of writing, placing it at a fresh 7-month low.

The declines comes amidst weekend press reports that all but confirm a clear commitment towards a 'no deal' Brexit on October 31 by the new UK administration. Michael Gove, the minister responsible for 'no deal' preparations, said the government was “working on the assumption” that Brussels would not strike the fresh agreement the UK government requires to avoid a 'no deal' exit.

Since coming into office, Prime Minister Boris Johnson has stated any progress towards a negotiated Brexit settlement can only be achieved if EU leaders agree to renegotiate the Withdrawal Agreement. Specifically, Johnson wants the Irish backstop clause removed in its entirety.

The EU have stated repeatedly the deal struck between Johnson's predecessor Theresa May and the EU is non-negotiable.

"While we are optimistic about the future, we are realistic about the need to plan for every eventuality. The EU’s leaders have, so far, said they will not change their approach — it’s the unreformed withdrawal agreement, take it or leave it," Gove wrote in the Sunday Times. "We still hope they will change their minds, but we must operate on the assumption that they will not."

Gove's comments are cited by Adam Cole, a foreign exchange strategist at RBC Capital Markets, as one reason for Sterling's underperformance on Monday:

"Cabinet minister Gove’s comments over the weekend that the government is operating on the assumption of no deal seem far removed from PM Johnson’s “million to one” characterisation during his campaign."

Gove will chair meetings of civil servants and political advisers every day until Brexit is delivered.

Sajid Javid - the new Chancellor - is meanwhile readying to announce an urgent spending platform to prepare for Brexit on October 31.

Javid told the Sunday Telegraph he will overhaul of the Treasury’s approach to Brexit, beginning with “significant extra funding” this week to get Britain “fully ready to leave” on time, with or without a deal.

The additional spending will include financing one of the country’s “biggest ever public information campaigns” to ensure individuals and businesses are ready for a 'no deal'.

He states that “all necessary funding will be made available” to ensure the UK is ready to leave the EU on October 31.

"Keep calm & stay bearish," says Emmanuel Ng, an analyst with OCBC in Singapore. "With PM Johnson peddling the hard line on the Brexit negotiations, and the Bank of England also turning its back on rate hikes, there might be little in the way of an upside for the GBP for now."

Sterling continues to grind lower

Above: Sterling paints fresh two-year lows against the Dollar.

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It is also reported that Dominic Cummings, Johnson’s most senior aide and an avowed Brexit 'hawk', summoned advisers to No 10 on Friday night and declared that the prime minister had tasked him with delivering Brexit “by any means necessary”.

The weekend headlines suggest a clear commitment to a 'no deal' Brexit by the Johnson administration, which makes for a stark contrast to the approach adopted by May's administration.

Sterling rallied last week, with gains coinciding with the transition of power from May to Johnson and many media sources attributed the gains to a 'Boris bounce', but we were sceptical instead suggesting that the gains were more likely a technical repositioning in the markets.

"We did not see fundamental justification for the Pound’s initial relief rally to be sustained while the risk of a “No Deal” Brexit continues to rise under PM Johnson’s new government. The promotion of hard Brexiteers to key cabinet positions is consistent with a government that will press hard to deliver Brexit at the end of October with or without a deal," says Lee Hardman, a currency analyst with MUFG in London.

The probabilities for a 'no deal' Brexit have never looked higher, and we believe markets are rapidly playing catch-up with this point.

Earlier on Monday, analysis by Citi, said markets were pricing in a 30% chance of a 'no deal' Brexit, against a 70% chance of a Brexit extension preceded by a General Election.

Yes a General Election taking place in 2019 is a strong prospect, but we wondered why the market was attributing such a low probability to a 'no deal' Brexit: there appears to be a lingering assumption that because there is a majority in Parliament against a 'no deal' it won't happen.

But, as noted by the government's most senior legal expert, Attorney General Geoffrey Cox, Johnson can force through a 'no deal' Brexit on October 31 even if his government collapses.

Cox said last week there is no legal process to halt the process – even if they force a no-confidence vote in the PM.

We would tend to agree: Parliament can frustrate the government but we don't see how they can force the government to go to Brussels to request another extension of Article 50.

If Johnson wants a Brexit by October 31, come what may, he has the power to do so.

If markets start raising the view of a 'no deal' Brexit yet higher - as they clearly are doing now - Sterling can go materially lower. If current market pricing for a 'no deal' is 30%, what would happen to Sterling under a 100% assumptiom?

"Downside protection on GBPUSD over the 3-month horizon is edging towards levels not seen since March where the UK threatened to slip out of the EU prior to the extension. This is occurring despite cable sitting a full 6 points lower than it did back in March (it was at $1.30+)," notes Simon Harvey, FX Analyst at Monexeurope. "This obviously begs the question "how much lower can the pound go?"

Harvey says current momentum and market positioning show markets think lower, or don't want to run the risk at least.

"We agree, targetting sub $1.20 this quarter on GBP/USD," says Harvey.

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