Pound Sterling Outlook: Brexit Risks Rising Again as EU Pushes for Hard-Landing

Political risks could weigh on British Pound

  • British Pound to Euro exchange rate: 1.1737
  • Euro to Pound Sterling exchange rate: 0.8519
  • Pound to Dollar exchange rate: 1.2456

Pound Sterling enjoys a strong start to the week having advanced against all its G10 peers.

The gains come just as the Brexit debate returns to dominate headlines after a short February hiatus, and there is a potentially frustrating development looming on this front. 

EU Brexit negotiators will take a 'divorce-first' approach to Brexit and expect to spend until the end of the year solely discussing the UK's EUR60 bn exit bill and the rights of expatriate citizens, with trade talks to come afterwards.

"The divorce-first approach would be a big setback for the UK, which is aiming for a fast-track EU trade deal by the end of 2018," argue analysts at UBS in response to the news.

If we consider that there are a mere two years within which to organise the divorce and then negotiate fresh trade terms, the prospect of the divorce taking months to settle will surely impact on the prospect of a decent outcome in the actual trade negotiations.

If Europe take a hard-headed approach on the matter, and choose to not hold simulatenous trade deal talks, then the chance of the UK defaulting to WTO rules after two years becomes all the more real.

No doubt this scenario would be desired by many in the European community that do want to see Britain punished, despite what they might say in public.

It also puts the onus on the UK to secure a transition deal at the earliest opportunity in order to avoid a cliff-edge.

The Pound would certainly welcome such an arrangement.

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One Eye on the Lords

The House of Lords will begin debating the Government’s bill to enable the activation of the Article 50 process to leave the EU.

The bill emerged unscathed through the House of Commons, and the Lords seem likely to make only modest tweaks.

"Whilst Parliament decided it was largely down to the Prime Minister to decide when to enact article 50, there are fears that the House of Lords will attempt to make amendments. Given the holiday over in the US, traders will be keeping a keen eye on the Pound for any significant volatility as the House of Lords discusses whether to approve the Brexit bill," says Joshua Mahony at IG in London.

Given that the Government does not have a majority in the House of Lords (with 304 Labour and Liberal Democrat members compared to 252 Conservatives), there is a decent chance that the Brexit Bill will be amended when the debate gets underway on Monday (20th).

Most analysts agree for the time being that any amendments do not seem likely to endanger the government’s end-March timetable for activation.

Depending on the extent of the proposed changes, activation could even coincide with the EU Council meetings scheduled for 8-10 March.

Eight amendments to the Bill have been tabled by the Labour party – ranging from seeking to guarantee the rights of EU citizens in the UK to ensuring that there is a “meaningful” vote on the outcome of the negotiations by Parliament.

"The former could well be passed given that a similar amendment was rejected in the House of Commons by a slim margin of just 42 votes," notes Ruth Gregory at Capital Economics.

We have seen over recent months that the Pound tends to like the idea of increased parliamentary scrutiny as it suggests a ‘softer-Brexit’ is a likely outcome. Therefore, should the Lords succeed in making ammendments to the bill we would expect this to be positive for the UK currency.

However - the picture is a little complicated as we would imagine if the Bill does in fact become bogged down in Parliament then an added layer of uncertainty could be introduced, and we know Sterling dislikes uncertainty.

When the Government pushed the Bill through the House of Commons without any problems we note Sterling rose as a clear time table was crystalising.

Brexit politics will therefore remain a nuanced driver for Sterling with some ammendments likley to be welcomed by the markets BUT should too many attempts to modify the bill by Parliemant stall the triggering of Article 50 in March, this could be negative.

GDP Figures Dominate Economic Calendar

The British Pound sees a thin economic data calendar this week, which could be a good thing if we consider the string of sub-expectations economic releases seen in mid-month have weighed on the UK currency.

A less-than-forecast rise in inflation, slower wage growth and declining retail sales – took the sheen off Pound Sterling’s improved performance seen in January.

“The data bear out the Bank of England’s view that economic risks are in both directions,” says Michael Sawicki at Lloyds Bank Commercial Banking. “If economic activity stays resilient, the surge in inflation induced by the currency drop would warrant a tighter monetary policy stance.”

Tighter policy implies interest rate rises which are in turn positive for Sterling as the UK offers greater return for global investors.

However, if purchasing power is squeezed as inflation rises and wage growth stays subdued consumer spending could lose momentum as the key driver of UK growth.

Clearly, this will weigh on the Pound.

The upcoming week is however not completely devoid of data as we receive second estimate of UK GDP for 2016 Q4 on Wednesday.

“Growth could actually be revised up a notch to 0.7% q/q and in any case is likely to have been reliant on the strength of consumer spending, but it is the extent of its resilience over the course of 2017 that will be increasingly under the microscope,” says Sawicki.

As things stand, no policy change seems are likely out of the Bank of England in the near term.

Bank of England Governor Carney and MPC members Haldane, Vlieghe and McCafferty will testify to the Treasury Select Committee (Tuesday) on the February Inflation Report, and may give some indication of how they weigh up the respective risks.

Budget Draws Close, Watch Government Borrowing Data

The Spring Budget on 8 March is also drawing closer.

Public finance data for January (Tuesday) will be the final release before the Chancellor’s fiscal update.

Markets are looking for a surplus of £14.4BN to be recorded.

Lloyds Bank Commercial Banking note January typically sees bumper receipts from self-assessment tax returns, but the outturn will also be flattered by forestalling resulting from a change in capital gains taxation in April 2016.

“A better-than-expected fiscal picture since last year’s Autumn Statement may give the Chancellor wiggle room for some fiscal giveaways for select cash strapped causes,” says Sawicki.

Fiscal stimulus could provide a boost for Sterling as it would suggest higher inflation rates in the future, and as observed, higher inflation tends to support a stronger Pound.