Sterling Deep in the Red after Merkel Kills Deal Hopes

Merkel kills off talks

Above: Angela Merkel, file image © European Union

- Pound at 1-month lows vs. Euro

- EU / UK look set for acrimonious split

- Merkel-Johnson phone call leaves talks teetering on failure

- But, talks are nervertheless still underway. Beware progress

Pound Sterling has suffered a sharp bout of volatility amidst reports that talks between the EU and UK have effectively been killed off by Germany's Angela Merkel. However, we caution that it is too early to write Sterling off as the two sides continue to negotiate amidst the headline drama, and if they are still engaged by next week's EU Council summit then a deal becomes highly likely.

Sterling took a dip Tuesday on media reports a morning call between Prime Minister Boris Johnson and German Chancellor Angela Merkel signalled negotiations were on the brink of failure, with a Downing Street source telling reporters that Merkel told Johnson there will be no Brexit deal unless Northern Ireland remains in the customs union "forever".

"Number 10 source says she said there could only be a deal if Northern Ireland stays in Customs Union, if not, then deal is 'overwhelmingly unlikely'," says BBC Political Editor Laura Kuenssberg.

The source says she repeated "forever" on "multiple occasions".

This is clearly a request the UK would not accept under its current negotiating position, as it would split the United Kingdom. It therefore looks like an agreement with the EU will be unachievable, now or in the future unless the political cards are shifted in the UK.

"Johnson will now go full steam ahead to a no-deal Brexit on 31 October. I would expect him to make a statement about all this later today," says Robert Peston, Politics Editor at ITV.

For Sterling, the prospect of 'no deal' expectations rising pose notable downside, and the balance of probabilities suggest the easiest route forward ins lower. “With very little common ground, there appears to be very little benefit in continuing to negotiate. A no deal is the most likely outcome, both sides will now focus their attentions on a blame game and finding the culprit,” says Artur Baluszynski, Head of Research at Henderson Rowe.

The Pound-to-Euro exchange rate is now at three-week lows at 1.1146, those with currency payments will see the rate on offer at banks now down to 1.0850-1.0930, independent providers will be quoting towards 1.1050.

The Pound-to-Dollar exchange rate is down at 1.2244, banks are quoting around 1.1914-1.20, specialist providers at around 1.2150.

"GBP/USD under pressure as Brexit negotiations are fast turning sour. After a few days of umming and arring, it seems that this one could begin to accelerate now Merkel has seemingly kiboshed deal prospects," says Richard Perry at Hantec Markets.

Sterling under pressure

Above: Sterling-Euro moves lower as evidence grows suggesting the UK and EU will not be able to reach agreement.

"If this represents a new established position, then it means a deal is essentially impossible not just now but ever. It also made clear that they are willing to torpedo the Good Friday Agreement," a Number 10 source told Kate McCann, Political Correspondent at Sky News, of the Merkel-Johnson call.

"The wording used by EU and UK representatives doesn't exactly contribute to reaching an agreement. Consequently, further mutual accusations may follow. Bottom line: The UK currency's roller coaster ride continues!" says Marc-André Fongern at MAF Global Forex.

The Spectator magazine triggered weakness in Sterling after reporting late on Monday the UK government is preparing for Brexit negotiations to end this week, citing a contact in Downing Street.

According to James Forsyth at The Spectator, Ireland's Taoiseach Leo Varadkar does not want to talk to the UK owing to his resistance to the UK's latest proposals to solve the Northern Ireland border question.

The response given by the Number 10 official to Forsyth is as follows:

"The negotiations will probably end this week. Varadkar doesn’t want to negotiate. Varadkar was keen on talking before the Benn Act when he thought that the choice would be ‘new deal or no deal’. Since the Benn Act passed he has gone very cold and in the last week the official channels and the backchannels have also gone cold. Varadkar has also gone back on his commitments - he said if we moved on manufactured goods then he would also move but instead he just attacked us publicly. It’s clear he wants to gamble on a second referendum and that he’s encouraging Barnier to stick to the line that the UK cannot leave the EU without leaving Northern Ireland behind."

The latest developments raise the prospect of further declines in Sterling; at the very least, the prospect of any potential gains will have diminished.

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It was also reported that French President Emmanuel Macron and German Chancellor Angela Merkel are not likely to push the European Union to discuss UK's offer until Ireland is ready to negotiate.

"There are quite a few people in Paris and Berlin who would like to discuss our offer but Merkel and Macron won't push (EU's chief Brexit negotiator) Barnier unless Ireland says it wants to negotiate", the source was quoted as having told Forsyth.

The developments suggest downside risks to Sterling are elevated, and we find it unsurprising that the currency is trending lower in the current environment.

"The Pound is holding on to yesterday’s losses. Information, allegedly leaked from the British Prime Minister’s office, points at the realisation within Boris Johnson’s camp that the current negotiations with the EU will break down and there will be a new delay to the exit date, which will be preceded by a new election," says Ricardo Evangelista, Senior Analyst with ActivTrades.

However, Evangelista does not foresee a substantial decline in the value of the Pound in the event that negotiations do break down, noting:

"There’s still no clarity on what the outcome for the Brexit process will be. Only a new parliamentary election, perhaps even a referendum, will be able to untie the Brexit knot. Until then Sterling is likely to remain within the current range."

However, we wonder if a 'no deal' Brexit has not almost become a certainty.

Even if a 'no deal' Brexit is avoided on October 31, it will likely occur in early 2020 if the Conservatives win a majority at the next election.

The Telegraph reports the Conservatives will fight the next election on a 'no deal' platform.

This should see them gather support from the Brexit Party. Indeed, Brexit Party leader Nigel Farage in the past said he would allow the Conservatives a free shot if he guaranteed to campaign on a 'no deal' ticket.

In a memo widely believed to be a text message sent by Dominic Cummings, Boris Johnson's chief adviser, Downing Street warns negotiations will "probably end this week" and that if the deal dies "it won't be revived".

"To marginalise the Brexit Party, we will have to fight the election on the basis of ‘no more delays, get Brexit done immediately'," the memo reads.

The outlook for Sterling, based on the above, is therefore negatively aligned.

We maintain that if the UK and EU are still talking by the time the European Council summit comes around on October 17, then the prospect of a deal is materially high.

This would open the door to further gains in Sterling, but a sizeable rally would likely only materialise once the Houses of Parliament have approved a deal.

Therefore, the probabilities of a substantial move higher in the Sterling-Euro exchange rate over the coming days are low.


But, Talks are Still Ongoing

Despite the media frenzy over suggestions Brexit talks are dead, and the UK and EU are hurtling head first into a 'no deal', it must be noted that talks are ongoing.

The UK and EU's technical teams are still engaged, and the European Commission's spokesperson this morning said she does not recognise the tone struck by Merkel in her conversation with Johnson.

Speaking at a regular press briefing, the spokesperson said the EU position "has not changed: we are working for a deal" and added that as technical talks continue today she does not see "how the talks could have broken down".

Furthermore, this afternoon Ireland's foreign minister Simon Coveney says he is working "flat out" with EU chief negotiator Michel Barnier to secure a deal.

Michael Gove, the minister for no-deal planning, says the UK still wants to leave the European Union with a deal but the bloc must move its position as London has.

"We hope that the EU will engage with us seriously, and in getting out these proposals we've moved, and it is now time for the EU to move too," he told parliament.

"If it does, then there is still every chance we can leave with a new deal. However, if the EU does not move, this government is prepared to leave without a deal on the 31st."

Talks are ongoing, and if you believe the EU negotiates to the wire, then there remains a chance the two sides agree a deal.

We maintain that if the UK and EU are still negotiating by the time next week's European Council summit comes around then a deal can be possible.

We would therefore expect Sterling downside to be protected as traders will be wary of the recovery potential in the currency until such a time as talks are declared officially dead.

BannerTime to move your money? Get 3-5% more currency than your bank would offer by using the services of a specialist foreign exchange specialist. A payments provider can deliver you an exchange rate closer to the real market rate than your bank would, thereby saving you substantial quantities of currency. Find out more here.

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