Pound Sterling Under Heavy Selling Pressure against Euro & Dollar after Markets Increase Odds of Australia-Style Brexit

- Brexit trade talks begin again today
- Johnson says Australia style Brexit
- GBP/EUR declines below 1.10 again
- But only 5% of 'no deal' Brexit says economist

Johnson comments Brexit trade deal

Above: File image of Prime Minister Boris Johnson. ©

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The British Pound plumbed a fresh three-month low against the Euro and a one-month low against the U.S. Dollar as investors withdrew capital from a country facing the dual prospects of a slow economic rebound from the coronacrisis and sub-par Brexit trade deal at year-end.

While UK deaths and infections from covid-19 continue to fall, the pace of the economic recovery looks set to be slower than that in other developed markets, with the European Council's latest Economic Sentiment Indicator showing the country's rebound lags that of its European peers. Meanwhile, there are concerns that fiscal and monetary policy support to the crisis in the UK also lags that of the measures taken in the Eurozone and U.S., which could make the UK economy a laggard over coming months.

But it appears that Brexit trade negotiations are where the real weakness in Sterling has arisen as the currency is lagging the majority of the world's major currencies suggesting an idiosynchratic factor is at play. The Pound started the new week on the back foot courtesy of weekend comments from Prime Minister Boris Johnson that the UK would be prepared to accept an Australia-style Brexit trade deal.

An Australia-style deal is a bare bones trade deal that is effectively built on World Trade Organisation terms and is therefore effectively a 'no deal' Brexit, the comments therefore represent the UK's hardening of rhetoric towards the EU on the matter and should contribute to the market's growing anxiety on the matter.

Johnson made the comments came during a telephone conversation on Saturday with Polish prime minister Mateusz Morawiecki.

"He said the UK would negotiate constructively but equally would be ready to leave the transition period on Australia terms if agreement could not be reached," read a statement to the press by Number 10 Downing Street.

The British Pound has come under pressure during 2020 thanks to a combination of a coronavirus-inspired market sell-off, Bank of England interest rate cuts and renewed Brexit anxieties.

The Pound-to-Euro exchange rate started 2020 at 1.1828 but is now trading at 1.0995 and bears will look at a potential fall to 1.0520 which represents the 2020 low for the pair, reached in March when markets were in meltdown owing to panic over the spread of covid-19 infections. The Pound-to-Dollar exchange rate started 2020 at 1.3253 but is now quoted at 1.2347 and could test 1.20 once more, and a break below here would occur on any substantial sell-off in the currency, although forays below 1.20 for the pair tend to be short-lived in nature.

However, one analyst says the losses for Sterling could be even greater.

"The Pound could drop below 1.00 against the euro for the first time if Britain exits the European Union on "Australia terms", as this would equate to a "hard Brexit"," says Robert Howard, a market analyst at Reuters. "Australia does not have a comprehensive trade agreement with the EU; much of EU-Australia trade follows default World Trade Organisation rules."

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Monday sees the EU and UK begin another series of negotiations that will run through July and are aimed at breaking the existing deadlock in trade talks, therefore the Pound is likely to be subject to headlines on the matter which should increase volatility in the currency.

German Chancellor Angela Merkel spoke with six European newspapers ahead of Germany assuming the rotating presidency of the European Union (EU) council on July 1.

"With Prime Minister Boris Johnson, the British Government wants to define for itself what relationship it will have with us after the country leaves," Merkel said.

"It will then have to live with the consequences, of course, that is to say with a less closely interconnected economy," added Markel. "If Britain does not want to have rules on the environment and the labour market or social standards that compare with those of the EU, our relations will be less close."

The standards referred to by Merkel concern the so-called level playing field provisions that the EU want the UK to sign up to. Under such a scenario the UK would follow EU rules on competition and standards to ensure UK businesses don't gain an advantage over their EU counterparts, which is an understandable request by the EU to make. Equally understandable however is the UK's hostility towards the demands as they effectively ensure the UK remains bound by EU law in some areas.

"We estimate EUR/GBP fair value at 0.85 on a ‘reasonable’ Brexit, but the chances of that happening are deteriorating," says Kit Juckes, Head of FX Research at Société Générale. (EUR/GBP at 0.85 gives a GBP/EUR rate of 1.1765).

Juckes expects the exchange rate to trade in a 0.89-0.94 range for much of the second half of 2020, while GBP/USD is forecast to trade at the bottom half of its 1.2-1.3 range for large parts of the second half of 2020. (EUR/GBP 0.89-0.94 range = 1.1240-1.0640).

GBP EUR forecast

The current round of negotiations will conclude at the end of July, but it is only in October when a final verdict on the status of talks will be likely, as per the comments made on the matter recently by EU Chief Negotiator Michel Barnier.

Therefore, while further progress is likely to be made over coming weeks some sticking points should remain in play right through to October and we expect only a high-level meeting of EU leaders will unlock a final breakthrough.

One analysts says that while markets are understandably apprehensive on the outcome of talks, progress should inevitably be made.

There are "some signs of hope," says Kallum Pickering, Senior Economist at Berenberg Bank. "Ongoing UK-EU negotiations for a comprehensive future relationship have turned more amicable of late. Although the UK has firmly refused to extend the transitional period beyond 31 December 2020, both sides are floating potential compromises that can unlock other areas of difference such as on governance, level playing field provisions and politically sensitive fisheries."

Berenberg no longer see a disorderly exit as the major risk but instead see a 35% chance the two sides can strike a deal worth its name before the end of the year.

On the downside, they see a 5% tail-risk of a disorderly hard exit.

"Despite signs of progress, we still do not expect a deal in time for the year-end. Instead, we expect the two sides to agree on some modest stopgap measures in order to prevent a disorderly hard exit. Instead of one big cliff edge, where the UK-EU economic relationship suddenly shifts from open single market rules to the much more restrictive World Trade Organisation rules for trade, we expect the two sides to see to it that the switch occurs in a series of smaller steps. We put a 60% probability on this outcome," says Pickering.

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