Pound Sterling Outlook: Reduced "Downside Risks" against Euro and Dollar say Wall Street Analysts

- GBP outlook more assured say strategists
- No "outright negative view" on GBP at Goldman Sachs
- Morgan Stanley raise prospect of Autumn Brexit trade deal

Brexit trade deal likely in Autumn

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Foreign exchange strategists at two leading Wall Street investment banks have told clients the outlook for the British Pound has improved amidst a more supportive Bank of England policy stance and the likelihood of a Brexit trade deal being agreed in the Autumn.

The call comes as the Pound continues to trade above the 1.30 level against the U.S. Dollar and 1.10 level against the Euro, an improvement on the 1.22 and 1.0913 lows seen for GBP/USD and GBP/EUR in late June.

Sentiment towards Sterling has improved of late amidst a broad based recovery in global equity markets which tends to support the UK currency against the Dollar and Euro, while the Bank of England's latest major policy update of August 06 confirmed the Bank was in no rush to cut interest rates to 0% or below; an expectation which had been a significant headwind for the UK currency during the 'coronacrisis' period.

"The BoE has provided a clearer message that QE is its preferred policy for the current set of circumstances, so negative rates should remain “in the toolbox,” perhaps in the bottom drawer, unless things change substantially. That makes UK policy a little less idiosyncratic, and this particular headwind looks less threatening for now," says Zach Pandl, Senior Economist at Goldman Sachs.

"An outright negative view on Sterling would require a more bearish macro backdrop," adds Pandl.

The Pound-to-Euro exchange rate is currently quoted at 1.1078 at the time of writing, and looks to be forming a short-term range above 1.1050 which is a near-term support level. The Pound-to-Dollar exchange rate is meanwhile quoted at 1.3080, with the psychological level at 1.30 looking to be a source of support. (Whether you’re emigrating overseas, buying a holiday home, or transferring a pension or salary, our partners at Global Reach can help you make smarter money transfers. The personal service from their dedicated Dealing team is what sets them apart; they focus on the details, so you don’t have to.)

Support for the currency is likely to extend over the coming week given there is not likely to be any major Brexit-related headlines, nor fresh policy guidance from the Bank of England which leaves the currency more prone to moves in the Euro and U.S. Dollar.

"We are now neutral on GBP as the more hawkish BoE rhetoric and reduced possibility for negative rates mean downside risks for the currency have been reduced, while the possibility of trade deal progress being made could lead to an upside surprise for GBP later in the autumn," says Sheena Shah, Head of G10 FX Strategy, Europe, at Morgan Stanley.

An autumn "upside surprises" for Sterling could well come in the form of a breakthrough on Brexit trade negotiations which are expected to culminate in an October meeting of EU leaders where the final details of a deal would be agreed.

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The EU and UK in July agreed to a further series of meetings and negotiations in an effort to agree a trade deal which confirms there remains a strong desire to see a deal agreed.

"Despite a lack of progress so far, we see agreement to more talks as a good sign, and still expect a political deal for a pragmatic solution in the autumn, plus a post-deal extension of transition to allow smooth implementation," says Economist Jacob Nell at Morgan Stanley.

EU and UK negotiators have made progress on the majority of issues put forward in trade negotiations, however there are a few problematic topics that have threatened to bring talks down altogether, a fear that aided a multi-week downtrend that ultimately culminated in the June lows of ~1.22 GBP/USD and ~1.09 GBP/EUR.

Outstanding issues remain EU fishing rights in UK waters and the EU's demand that the UK follow some EU rules in the future to ensure UK companies don't gain a competitive advantage over EU counterparts.

This so-called level playing field provision is in fact proving to be the major stumbling block and is where we would imagine the focus of talks will lie through the course of August, September and October.

"There are positives: media reports suggest the EU is contemplating easing some of the level playing field demands; and the negotiators have now agreed to further talks," says Nell. "Given incentives to avoid a bad outcome, we expect a deal on goods in the end."

Expect a lingering element of uncertainty towards Sterling to be displayed by markets through the coming three months, a stance that will keep Sterling strength capped. A deal will only likely be agreed at the political level as is customary with EU leaders who tend to use EU Council summits to make the final breakthroughs.

Therefore, October will in all likelihood prove to be a key moment for the Pound. "Rather than gradual emergence through technical talks, we expect an autumn breakthrough at the political level," says Nell.

Morgan Stanley see a "mixed deal" as being most likely, which envisages close alignment on goods trade, with the UK out of the single market, the probability of reaching such an outcome is now deemed to be at 60%, up from 50% previously.

"Both sides, we think, have a strong incentive to avoid reverting to WTO terms of trade on goods, and a joint "landing zone" with respect to common standards seems feasible to us," says Nell, "perhaps along the lines of the UK adhering to current EU rules and standards, with a non-ECJ dispute settlement mechanism to resolve disputes over divergence."

A "bull case" for Sterling and UK assets would see the EU and UK agree a "double deal", whereby the UK offers the EU access to its fishing waters in exchange for access to the EU financial services market.

This is given a 15% probability, down from 20% before.

A bad outcome 'no deal' is given a 25% probability, down from 30% previously.

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