- GBP drops after Frost comments to MPs on state of talks
- Brexit increasingly important for GBP moves once more
- Options market hint at heavy volatility in June for GBP
- Expect markets to focus on mid-June meeting of EU leaders
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- GBP/EUR spot: 1.1132 | GBP/USD spot: 1.2285
- GBP/EUR bank rates: 1.0920 | GBP/USD bank rates: 1.2015
- GBP/EUR specialist rates: 1.1032 | GBP/USD specialist rates: 1.2150
- Find out more about the above
The British Pound is trading softer against the Euro, U.S. Dollar and other major currencies as foreign exchange market participants increase expectations that trade negotiations between the EU and UK will fail to result in a deal, following a briefing on the state of talks by the UK's chief negotiator.
David Frost told Parliamentarians that the EU needs to evolve its position in order to reach an agreement, as the policy enshrined in the EU's mandate to its negotiating team isn't one that can be agreed by the UK.
The Pound-to-Euro exchange rate fell 0.80% in the wake of the developments and is quoted at 1.1129 on Thursday, while the Pound-to-Dollar exchange rate fell by 0.60% and is now quoted at 1.2260.
"The British Pound rallies when the UK moves toward deeper integration with Europe, and falls when the UK moves towards a no-deal Brexit decision," says Erik Norland, Executive Director and Senior Economist of CME Group.
Above: Rise and fall of GBP/EUR on contradictory trade negotiation headlines.
Norland says investors have been reminded of this theme once again as UK and EU negotiations hit an impasse, "with both sides citing a lack of progress on issues ranging from fishing rights to business-competition regulations".
The analyst says since the negotiations stalled, the Pound has slid 3% versus the Euro and 4.5% versus the U.S. Dollar.
In his appearance to MPs Frost did however remind markets that there is a still a long way to go before it can be judged talks have failed, as he told MPs on Parliament's Brexit committee that negotiations are still "at a relatively early stage", and although he would like to move on to the next stage of discussions they are not quite there yet.
He said that he expects Prime Minister Boris Johnson to travel to Brussels in mid-June and meet with leaders directly in order to try and push talks along.
He said it would be expected that Johnson would meet with leaders following the EU Council's conference to discuss progress on Brexit, and this would typically be where a breakthrough might occur.
Frost's comments on the issue of fisheries - which have been a major sticking point to progress - are also interesting in that a deal does not necessarily have to be made by June. Frost said agreement on fisheries was "not an absolute requirement" to trade talks progressing beyond June. So while it is a sticking point, it won't kill negotiations.
We therefore feel that while Sterling has declined in the wake of Frost's confirmation that talks are currently at an impasse, there will be more significant moments to focus on in the month ahead.
Regardless, market nerves will almost certainly keep a lid on Pound Sterling's ambitions as Frost reminded MPs that the UK will not agree to extend the transition period.
The EU's Chief Negotiator Michel Barnier meanwhile wrote to the Brexit Committee saying the EU remained open to a two year extension of the negotiating period, but Frost rebuffed the suggestion saying it was right for the UK to cease paying into the EU's budget by year-end, when the transition period runs out.
The move lower in Sterling comes just 24 hours after we reported a pop higher in the currency following a report that the EU had apparently shifted position on the contentious issue of fishing rights. The EU has thus far claimed it would require full access to fishing waters, but the UK has said such a right could only be granted by a nation that has full EU membership.
The rise and fall of the Pound suggests the UK currency is now entering a new phase, whereby it becomes increasingly reactive to headlines concerning the state of negotiations. Therefore, we would expect to see heightened volatility in key Pound exchange rates through the course of June as various deadlines are met.
Next week sees the final round of remote negotiations between the two sides, ahead of a mid-month meeting of EU leaders. We would expect the market to be highly reactive to the outcome of the meeting, and to any progress made by the Prime Minister's visit to Brussels.
This is of course assuming the covid-19 crisis allow for such face-to-face meetings.
The end of June is the deadline by which the UK and EU can formally agree to extend talks. An extension would be seen as positive for Sterling, whereby deadlock and no extension by this point will probably lead to more sustained selling pressures.
"June marks the UK’s deadline for applying for an extension to the December transition deadline. Should it decide not apply, in an environment where the European Union is more focussed on managing the pandemic than on Brexit, risks to trade will could come into focus," says Daniel Been, Head of FX and G3 Research at ANZ.
CME Group's Norland reminds us of how volatile Sterling can be when 'deal / no deal' anxieties start to rise:
"Since the referendum, GBP has tended to rally when it looked like a deal was close (+21% versus USD into early 2018 as then Prime Minister Theresa May held negotiations) and tended to sell off when Brexit appears to be headed towards the “no-deal” scenario (-16% when May’s deal was repeatedly defeated)."
Norland notes that going into this next round of negotiations, GBP options markets are more skewed to the downside than usual with out-of-the-money (OTM) put options substantially more expensive than usual compared to OTM calls.
Image courtesy of CME Group
This suggests significant buying of protection in case of a deep slump in the value of the Pound.
"By May 19, the options skew (also called risk reversal) was more negative than it had been 92% of the time during the previous two years. Options traders have, at times, proved prescient with respect to future moves in the Pound: options skew was extremely negative in the lead up to the 2016 referendum and, indeed, GBP collapsed after the result became apparent," says Norland.
The analyst adds that while "skewness" isn’t as negative this time, Pound options are considerably more expensive than those on Euro when seen from a U.S. Dollar perspective.
"Moreover, most of the recent spikes in both implied volatility and risk reversal have been motivated by concerns over the progress of Brexit negotiations. The one exception occurred during an incipient dollar-funding crisis in mid-March. After the U.S. Federal Reserve stepped in, that issued was resolved quickly," says Norland.
The Issues Holding Up Progress
Frost told MPs he thinks there remains a fundamental disagreement on most aspects of the level playing field provisions the EU demands.
"The EU is still coming to terms with the fact that there's a large country in Europe that doesn't want to be part of the EU's structure in some way, or to work on EU norms, or to relate to the EU as the reference point of its activity," said Frost.
The EU is seeking to ensure the UK signs up to a host of rules and regulations that would dictate how the UK economy and industries operate, in order to ensure the UK does not gain an unfair advantage over its cross-channel rivals.
The UK argues that such conditions are not applied to other countries that have already signed trade deals similar to that which they are now seeking.
Frost told MPs because the EU are looking to apply stricter standards on the UK than they have required of other nations it leaves him "skeptical that Level Playing Field provisions in the EU side are much to do with access and they're more about control".
For those watching the value of the Pound it appears the market is entering a familiar phase whereby volatility increases ahead of key negotiating deadlines.
"Undoubtedly Sterling becomes increasingly exposed to headline risks around Brexit as we move out of the worst of the Covid-19 pandemic and back into the cut-and-thrust of negotiations," says Wilson.
Expect Sterling to become increasingly reactive to trade negotiation-related headlines as we move through June. Early June sees the final round of negotiations take place, while mid-June sees EU leaders hold a summit to discuss progress.
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