Signs of Brexit Agreement Make Pound Sterling the Day's Best Performer

Trader exchange rates

The British Pound advanced higher on reports the E.U. and U.K. are making progress on Brexit negotiations and analysts tell us they see the potential for further advances.

The Pound surged to it's best level in weeks against the Dollar and Euro in late London trade as markets gave a sigh of relief that Brexit negotiations were heading in the right direction.

But, some market commentators fretted over a late-in-the-day intervention in the Brexit debate by the E.U. parliament's leader Guy Verhofstadt who warned not enough progress has been made on issues to progress talks.

Verhofstadt wrote to chief Brexit negotiator Michel Barnier expressing concerns over progress on citizen rights and the Irish border as a reaction to the shift in sentiment over the 'brexit bill'; but what commentators need to remember is that the E.U. parliament doesn't get a say as to whether talks can move from once stage to the next - only E.U. leaders can.

"Recent wire reports suggest that the EU Parliament still thinks more work has to be done. This knocked back sterling temporarily, but the parliament itself of course has little say on the matter. The real decision comes later, and until then, the market is still pleased to see progress on this thorny issue. Just a few small other issues to resolve as well," notes Chris Beauchamp, an analyst with IG.

The Pound therefore saw no reason not to extend gains and momentum extended into the close.

The rally in Sterling has been sparked on reports the reports U.K and E.U. negotiators have confirmed that an agreement-in-principle has now been reached, opening the door to a potential breakthrough in the talks this December.

Further reports confirm another meeting of the U.K. cabinet has approved proposals to pay the E.U. anywhere between EUR45-55bn after Brexit due to long-term liabilities; confirmation of Government unity on the matter.

Of course both sides of the Brexit commentariat in the U.K. are scathing in their assessment of the developments with Remainers saying this is further proof of the unneccessary cost of Brexit (this money was going to be paid anyway!) and Brexiteers saying the bill is too much (this group are not content on simply having a Brexit, they want a confrontational Brexit!).

Whatever the chattering classes say, the verdict from the market is positive as the breakthrough - which still requires all the remaining 27 E.U. states to agree to - will finally allow talks to move on to the issue of trade and the future relationship which should finally allow businesses some clarity.

"If made official, this would be a major achievement for Prime Minister May but for the time being its nothing more than hope. Although Ireland's political troubles and their border issue could remain a problem, the Brexit bill agreement should be enough to unlock the talks," says Kathy Lien, Director at BK Asset Management.

This clarity should feedback into a stronger Pound.

“We are still taking as our base-case a view that the UK finds a way to promise sufficient clarity on the financial settlement to allow for a positive surprise, which is the key to our relatively bullish GBP forecasts,” says Shahab Jalinoos, a foreign exchange strategist at Credit Suisse.

The Pound-to-Euro exchange rate spiked as the news reached the market with the pair moving from the 1.1140 area up to 1.13. However, if we look at the below graphic, the market remains in familiar territory and is yet to really push higher.

Pound to Euro exchange rate

Indeed, some analysts are sceptical as to just how much more progress the Pound can make on the news, particularly against the Euro.

"We still think it is still too early to price out Brexit risk premiums, as there are still many unresolved issues about what Brexit really means even if (when?) phase 1 is concluded," says analyst Mathias Røn Mogensen at Danske Bank. "In the absence of any further positive news today, we could see EUR/GBP climbing back above 0.89 again."

EUR/GBP above 0.89 gives a GBP/EUR staying below 1.1235.

The Pound-to-Dollar exchange rate rose to 1.3380 having been as low as 1.3220 ahead of the news breaking. If we look at the graphic, the recovery keeps alive an ongoing uptrend in the exchange rate.

Pound recovers

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"Investors cheered the news by erasing all of GBP/USD's losses and turning the pair positive for the day," says Lien.

"GBP rallied in response to the media reports and we suspect that the currency could remain supported for now," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

Marinov says if the agreement is confirmed it would represent a potentially very important step towards trade negotiations between the UK and the EU.

"In turn, this may help alleviate the worst of the Brexit unease of investors and businesses alike ahead of the announcement of the British Brexit offer next week," adds Marinov.

Analyst Derek Halpenny at MUFG says the latest developments back his view that Sterling can go higher from here:

"The Pound would be stronger today were it not for that lingering uncertainty over the Irish border. Assuming this does not thwart progress, our year-end GBP/USD target of 1.3600-1.3700 is clearly achievable. Furthermore, levels over 1.4000 next year are also achievable based on actual economic growth being stronger than the building consensus of economic weakness in the coming year," says Derek Halpenny at MUFG."

Not There Yet

The above being said, Crédit Agricole are cautious that other issues like the rights of the EU citizens in the UK as well as the dispute about a post-Brexit border between Ireland and Northern Ireland still have to be resolved.

Indeed, the question of the Irish border could yet disappoint as the Irish have said they are looking to exercise a veto on progressing talks should they feel the U.K. has not given enough guarantees that no inter-Ireland border will be resolved.

The border issue is indeed a tricky one and we have yet to see any reports that fresh suggestions have been put forward by the U.K.

"The UK appearing to be gradually bowing to EU demands – a logical development – is likely to be perceived as a tailwind for Sterling because it reduces the likelihood of a disorderly Brexit. However, the currency is likely to remain exposed to the flow of news headlines, especially because negotiations on the Irish border remain challenging," says Roberto Mialich, FX Strategist with UniCredit Bank in Milan.

Therefore, "although Sterling is likely to trade with an upside bias, we would advise keeping any long exposure fairly low for now," says Mialich.

However, Callum Pickering, Senior UK Economist with Berenberg Bank believes Ireland and the U.K. will soon find common ground:

"That the UK has dropped its hard-line view on the Brexit bill - the most contentious issue on the UK side - signals that London is now serious about moving the talks forward. Meanwhile, the lessening of Dublin’s own political upheaval strengthens this prospect. Expect the UK to strike the necessary compromise with Dublin to settle the Irish question soon."

Berenberg believe progress to transitional and trade talks at the 14 December EU summit would be taken well by markets and underpin a rebound in Sterling and add some upside risk to their near-term growth calls for the UK (1.6% in 2018 and 1.7% in 2019).

Berenberg's base-case assumption (70% probability) on Brexit progress is that by late 2018 the UK will accept a transition deal, possibly similar to the Norway deal minus some financial market privileges, for 2 or 3 years.

The Road Forward

Talks will continue at until Monday, 4 December, which is the deadline by which the United Kingdom will have to present its final proposals on the three issues - the Irish border, the divorce bill and the rights of E.U. citizens living in the U.K.

On Monday, Theresa May will meet with the President of the EU Commission, Jean-Claude Juncker, and with the EU’s chief Brexit negotiator, Barnier, ahead of the summit on 14-15 December, at which the EU will have to judge whether or not “sufficient progress” has been made to move on to the next phase of the negotiations.

Analysts tell us further signs of progress could fuel the Pound's recent recovery.

"Positive developments in this direction would aid a further appreciation of the Pound, both against the dollar (with the exchange rate possibly reaching or beating September highs in the GBP/USD 1.36 area) and against the euro (with the exchange rate possibly returning towards EUR/GBP 0.86-0.85)," says Asmara Jamaleh with Intesa Sanpaolo.

EUR/GBP 0.86-0.85 gives GBP/EUR at 1.16-1.1760.

Analyst Kit Juckes with Société Générale believes any good news on Brexit negotiations will likely reverse much of the Pound's recent undervaluation:

"On its own, that is ‘good news' but not game-changing. Agreeing a way forward on the border between the Irish Republic and the UK is a bigger challenge at this point, and still stands in the way of moving on to the next stage of negotiations. But Sterling's current valuation is so poor that any small piece of good news is enough to trigger a disproportionate response."

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