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British Pound Today: EU Agree Brexit Extension, PIMCO go Overweight Sterling

Donald Tusk

Above: File image of Donald Tusk, © European Union.

- Pound-to-Euro exchange rate @ 1.1567

- Pound-to-Dollar exchange rate @ 1.2839

- EU's Brexit delay provides some downside protection

- PIMCO go overweight Sterling

The British Pound is seen trading with a slightly positive tone at the time of writing on Monday morning following the agreeing of a Brexit extension by the EU, while one major financial services institution saying they are now going 'overweight' the currency.

Sterling has eased back from multi-week highs over recent days, but the currency remains well supported as markets gauge the threat of a 'no deal' Brexit has receded notably since July, a view that has gained impetus with the granting of another Brexit extension by the EU.

The European Union has on Monday agreed to a 'flextension' - a delay to Brexit that will last until January 2020, but keeping open the opportunity for the UK to leave the EU should it ratify a deal sooner.

"The decision to provide an extension must be seen as a positive thing, given how close we are to a disorderly Brexit," says Joshua Mahony, Senior Market Analyst at IG.

Announcing the decision, European Council President Donald Tusk said "the EU27 has agreed that it will accept the UK's request for a Brexit flextension until 31 January 2020. The decision is expected to be formalised through a written procedure."

From a currency market perspective, the granting of the extension appears to have already been 'priced in' to Sterling, hence why the Pound has offered something of a static response to the development.

Instead, markets appear to already be looking towards the next challenge for the currency: a 2019 General Election.

The likelihood of a December election has risen after the SNP and Liberal Democrats indicated they could support a General Election on December 09.

Labour are known to be resistant to an election meaning the Government's route to an election - which requires a two-thirds majority to pass in Parliament - looks to be a non-starter.

However, the Liberal Democrats propose bringing a one-line Bill before parliament that would require a simple majority to pass. Therefore, Labour support is not required under this plan.

Under the proposed timeline of the Lib Dem plan, Parliament would debate and vote on the one-line Bill on Tuesday and Wednesday, with royal assent granted on Thursday and Parliament dissolved by the weekend.

For Sterling, the prospect of a General Election poses uncertainty, and currencies tend to underperform when political uncertainty is on the rise, as is currently the case.

So while the Brexit extension is providing support, growing odds of an election are providing pressure.

"We see prospects of an early election as negative for GBP given that it would tame optimism about the withdrawal agreement being reached – the key driver of GBP gains this month – and reintroduce uncertainty into sterling," says Petr Krpata, a foreign exchange strategist at ING.

However, Krpata adds that "given that the odds of a hard Brexit has decreased (in the case of a Conservative majority scenario after the election) compared to the state of affairs three weeks ago, we see GBP downside as more limited now too."

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Pimco go Overweight Pound Sterling as 'No Deal' Brexit Risks Recede

Pimco, the largest bond fund in the world, has started buying more Pounds, according to Geraldine Sundstrom, managing director and portfolio manager at the fund, our reporter Joaquin Monfort reports.

The portfolio manager is more confident in buying Sterling because of the low probability of a ‘no-deal’ Brexit, saying “this would push you to be a little bit more overweight on UK Sterling currency and underweight Gilts, in general.”

Previously, asset managers had steered clear of Sterling and most Sterling-denominated assets (except for large caps which benefit from a weak Pound because of their multi-national reach) out of fear of a 'no deal' Brexit materialising.

But following moves by Parliament to prevent a ‘no-deal’ and the subsequent reaching of a deal between Boris Johnson and his EU counterparts, the risks of a ‘no-deal’ have dramatically declined.

“We are not too sure exactly what will happen but certainly we have a better idea of what will not happen,” says Sundstrom. “And I think this has made us a little bit more comfortable in assigning a rather large probability that a cliff-hard Brexit will not happen.”

Blackrock, the largest asset manager in the world, has also noticed an increase in interest in its clients for purchasing Sterling-denominated assets following recent positive Brexit developments.

“We have definitely seen investor interest come back into UK domiciled assets: UK equities, in particular, with a preference for mid and small cap because of the positive correlation with Sterling,” says Wei Li, head of ishares EMEA investment strategy at Blackrock.

Li says that the almost zero percent probability of the UK crashing out without a deal means Sterling has a ‘floor’ but to go much higher investors would need more clarity on Brexit implementation and/or the probable outcome of a general election.

“For Sterling to go significantly higher we would need more news over whether a revised time schedule could potentially speed up the legislative process or around clarity in terms of an election, which is looking increasingly inevitable,” says Li.

Renewed interest in UK assets is likely to be tempered by continued uncertainty surrounding how the new trade relationship between the UK and Europe - and UK and the rest of the world - will look in reality.

“Even if we do end up agreeing on an exit deal, that is just the beginning of a lengthy process that has yet to start around negotiating future trade relationships with the EU and the rest of the world, so I think we are in for a prolonged period of uncertainty for a long time, and I am definitely not expecting a ‘V’ shaped rebound,” says the Blackrock strategist.

Pimco thinks there are wider, global, forces at play that impact on investment decisions regardless of Brexit, and that these may be signaling a possible ‘late-cycle bounce’.

“There is a chance of a late-cycle rebound but what you really have to look at is the U.S - China relations. This is what, on a global scale, has dampened investment and capex, and, therefore, this is where one should look at,” says Pimco’s Sundstrom.

The improvement in trade relations between the superpowers is a positive development that should help investor risk appetite.

That, as well as greater monetary and fiscal easing, means there is a “decent chance of a cyclical bounce towards the start of 2020,” says the portfolio manager.

HSBC, one of the largest currency dealers in the world, also now sees a floor under Sterling due to the low probability of a hard-Brexit, although it sees new risks to the currency from a general election.

“The main current downside risk to GBP centres on the possibility of a general election and the associated uncertainty,” says Daragh Maher, head of research at HSBC.

The probability of a general election hinges on the length of the delay the implementation of Article 50 decided on by the EU.

If the EU decides the delay should last till January 31 Boris Johnson has said he will call a general election. If it is a short delay there probably won’t be an election.

Currently, Ireland has said it favours a January 31 deadline and France, a shorter 2 week delay, to November 15.

In the event that a deal is agreed and implemented smoothly, HSBC expects GBP/USD to spike to 1.35 and then 1.40-45 eventually.

It is more positive about the prospects for investment in UK companies in the scenario where the UK enters a smooth Brexit, despite the continued uncertainty over how the final relationship will eventually look.

HSBC say the focus for Sterling would shift from politics to economic data.

“HSBC’s economists note that this could boost business investment and consumer confidence, while lower inflation from a stronger GBP could help support real incomes,” says Maher.

The stronger economy envisaged would result in the Bank of England (BOE) probably shifting its stance to more hawkish, meaning in favour of higher interest rates.

This would support the Pound since higher interest rates generally attract greater foreign capital inflows attracted by the higher returns, and this boosts demand for the currency.

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