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Pound Sterling Extends Gains, Court Rules Suspension of Parliament Unlawful

Exchange rate trader

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- Sterling extends higher mid-week

- Scottish court rules suspension of parliament unlawful

- Germany's Merkel says Brexit deal can be struck on "the last day"

- But 'good news' now fully absorbed by Sterling says TD Securities

- Pound to come back under pressure in November / December say ING

The British Pound extended its short-term recovery impulse against the Dollar, Euro and other major currencies in mid-week trade with the theme of diminished chances of a 'no deal' October 31 Brexit maintaining its grip on the UK currency.

It has on Wedneday been ruled by a Scottish court that the Government of Prime Minister Boris Johnson acted unlawfully when they prorogued parliament on Monday, and there are calls by senior opposition MPs for Parliament to open its doors immediately.

Scotland's highest court of appeal ruled the decision to advise the Queen that parliament should be suspended was unlawful.

"That does not (yet) change the prorogation itself. Though of course will add to pressure," says Dr. Catherine Heddon of the Institute for Government. However, Heddon notes, that it is "a matter of fact Parliament was prorogued. As a matter of law that is a different matter."

This draws questions on whether Parliament can indeed sit before any appeals are heard, and Labour's shadow Brexit secretary Kier Starmer has said Parliament should open its doors at once. 

The Government will appeal this ruling to the Supreme Court, which on Tuesday will rule on a separate case brought forward by pro-remain advocates in London, the finding of the Supreme Court should ultimately settle the matter.

The issue is significant for Sterling in that markets judge that Parliament ultimately proves a significant guard against a 'no deal' Brexit. Indeed, Parliament's ability to pass a law that effectively outlaws a 'no deal' Brexit before it was suspended on Monday is widely cited as being behind Sterling's current run higher.

Perhaps more supportive for Sterling are the Government's ongoing attempts to strike a Brexit deal, regardless of Parliamentary hostililty to the Prime Minister's approach.

Talk of an all Ireland customs plan for agricultural goods, as an alternative to the Northern Ireland backstop has appears to be gaining traction. It is expected Johnson will continue negotiating as long as he can, and the October 17-18 meeting of the European Council of EU leaders will be key in this regard.

German Chancellor Angela Merkel said on Wednesday there was still every chance for Britain's divorce from the European Union to take place with a deal.

"We still have every chance of getting an orderly (Brexit) and the German government will do everything it can to make that possible - right up to the last day. But I also say we are prepared for a disorderly Brexit," Merkel told German lawmakers.

"But the fact remains that after the withdrawal of Britain, we have an economic competitor at our door, even if we want to keep close economic, foreign and security cooperation and friendly relations," Merkel added.

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However, foreign exchange strategists at global investment bank TD Securities have drawn questions on Pound Sterling's ability to run much higher from here, saying the currency's inability to push higher following the release of some strong UK employment data was particularly telling.

For Ned Rumpeltin, European Head of FX Strategy at TD Securities in London, the failure of Sterling to push higher after the release of data that shows UK wages have hit an 11-year high proves that it is still the Brexit story that really matters to the Pound.

And on this front, the positives might be starting to dry out.

According to Rumpletin, "the run of 'good news' on the Brexit front may be coming to an end - and with it, the rebound Sterling has enjoyed in recent days."

The Pound has enjoyed a strong rally of late: the Pound-to-Euro exchange rate climbing from mid-August lows at 1.0724 to trade back above 1.12 this week, it has since pared back to 1.1183 at the time of writing.

The Pound-to-Dollar exchange rate has meanwhile recovered from a September 01 multi-year low at 1.1959 to trade at 1.2370 at the time of writing.

Analysts and market commentators are almost unanimous in their opinion that Sterling's recent rise is largely a result of a rapid decline in expectations for a 'no deal' Brexit to transpire on October 31; something that Prime Minister Boris Johnson was willing to facilitate if he failed to achieve a new deal with the EU.

Parliamentarians have however managed to legislate against a 'no deal' Brexit, while also denying the Prime Minister his request for a mid-October General Election which if won by the Conservatives would have ensured a 'no deal' was firmly back in contention.

But with Parliament now suspended there is a chance Sterling will over coming days be less headline driven than has been the case of late.

"Data has been playing a distant second fiddle to Brexit in recent months. With Parliament now suspended, however, the FX market had a chance to pivot back to more traditional fundamentals," says Rumpletin.

Pound vs. Euro
Above: Sterling-Euro's recovery since mid-August remains intact on a technical basis.

Rumpeltin does however say it is notable that Sterling largely ignored what he describes as "a very strong set of employment data Tuesday, pointing to some risk that GBP's positive run is losing steam."

The ONS on Tuesday reported average wages, with bonuses included, grew 4.0% in July, well ahead of market expectations for a reading of 3.7%.

And, 31K jobs were added to the workforce on a three-month-on-three-month basis: the economy therefore continues to provide employment and wages are on the up.

The rolling three month unemployment rate also slip back unexpectedly to 3.8%.

In normal times, this would be particularly beneficial for Sterling as it would mean the case for a series of Sterling-supportive interest rate rises at the Bank of England has increased substantially.

"Sterling's lack of follow-through in the wake of this better data is telling, we think. The fact that we did not see a further extension in cable upside suggests that the good news may now be in the price - at least for the time being," says Rumpeltin, adding:

"Investors were handed a golden opportunity to chase further gains, but spot failed to push above key near-term resistance around 1.2382. This, we think, could leave us vulnerable to a pullback, particularly if we get any negative catalysts on the Brexit front from No 10 or from risk appetite in general."

Sterling-Dollar floor

Above: Sterling-Dollar's recent recovery in the context of a broader decline

Some analysts do however believe Sterling can extend higher from here in the short-term, but on a multi-week time frame notable risks remain.

Foreign exchange strategist Peter Krpata with ING Bank N.V. has written to clients saying for now, Sterling may enjoy a calmer period with occasional upside caused by the still-stretched positioning.

However, the analysts says pricing on options markets - where contracts are bought to protect against future periods of volatility - shows the market is expecting the calm to be broken.

"Given our base case for early elections in late November / early December (likely to be triggered by a vote of no confidence) we expect GBP to come back under pressure," says Krpata.

Sterling risk reversals

Danger ahead: Expectations for future volatility on a two month basis have fallen faster than the same expectations on a three month basis, suggesting investors see the potential for heightened volatility in November/December. Image courtesy of ING.

Elections pose risks for the Pound: a Conservative majority would once again raise sharply the prospects of a 'no deal' Brexit shaping up at some point, while a Labour majority introduces the prospect of a socialist government taking the reins, and unprecedented outcome for a major Western economy in recent history.

"This suggests that the current subdued risk premium in the Pound will increase, in turn weighing on the currency," says Krpata.

ING expects EUR/GBP to converge towards the 0.95 level and GBP/USD to fall below 1.20 over the next three months.

0.95 in EUR/GBP equates into a GBP/EUR exchange rate of 1.0526.

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