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UK Brexit Minister Robin Walker says the UK and EU are "very close" to a transitional Brexit deal, analysts tell us why this is positive news for Pound Sterling.
The British Pound was bid higher at the start of the new week with a good portion of the gains coming on news that a British official involved in negotiating Brexit believes a transition Brexit deal will likely be struck this month.
Robin Walker - who serves as Parliamentary Under Secretary of State at the Department for Exiting the European Union - said in a speech at the Institute of Directors that "we recognise how important it is to secure the deal on the implementation period as soon as possible. I want to stress that we are very close to a deal at this time.”
Businesses want to avoid disruption and uncertainty, and with a final Brexit deal some months off a transitional period will allow them to plan ahead. This should therefore be supportive to the UK economy, and by extension, its currency.
Analyst Viraj Patel with ING Bank N.V. attributed a spike higher in Sterling to the news, serving to confirm the importance of the agreement of a transitional Brexit period to the British Pound.
The Pound-to-Euro exchange rate climbed back above the 1.12 level and looks like it could make a move on the 1.13 pivot which is the level it has been trading around for six months now.
The Pound-to-Dollar exchange rate rose above 1.3850, but still remains some way off its 2018 highs just north of 1.43.
We are told that for those highs to be tested once more, the Pound will need confirmation of a transitional Brexit deal before the end of March.
"Sterling bounces a tad higher as UK Brexit Minister Robin Walker says UK-EU are 'very close' to a Transition Deal. Near-term focus for GBP remains on the 22-23 March EU leaders summit – and the odds of a Brexit transition deal being struck this month. If agreed, GBPUSD to 1.40," says Patel.
Sterling's 2018 high against the Euro is at 1.1507 which was reached in January, when Brexit-based headlines were yet to weigh on the currency. The Pound has since slipped down to the bottom of its range and recorded a 2018 low of 1.1152 on March 07.
Sterling struggled through February and into March as the European Union put further pressures on the UK to yield to their position, with another flare-up over the question of the Irish border looking to be a key area of contention.
"The main risk to securing a transition deal could be ongoing disagreements over other withdrawal issues such as the Irish border," says Lee Hardman, a currency analyst with MUFG. "The longer that it takes to secure a transition deal, the more likely the Pound is to come under some renewed downward pressure."
However, MUFG continue to maintain a base-case scenario that a deal will be struck soon which supports their "outlook for a stronger Pound."
The Daily Telegraph meanwhile published a report at the start of the week stating that UK is close to securing a transition deal at the upcoming EU Leaders’ Summit on the 22nd and 23rd March.
According to the report, the European Commission was “impressed” by the UK team during negotiations in Brussels last week.
One unnamed EU diplomat was quoted as saying “the UK was seriously prepared”, and that “it seems that let’s get on with it means let’s get on with it”. A second unnamed EU diplomat was quoted as saying “it is clear that the UK has a strong will to reach an agreement on a transition period”.
Lefteris Farmakis, an FX strategist at UBS Group, also sees the prospects for a firmer Pound on a transitional deal being struck:
“Both the prospect and the timing of a transitional deal on Brexit remain highly uncertain. If such a deal does take place, however, it could be an important positive development for Sterling in the near-term by reducing 'cliff-edge' risks."
Negotiators have until the March 22 European Council summit to agree on the terms of a transition period in order for it to be approved by heads of state from across the European Union at the summit.
Only once a transition is agreed, can negotiators then begin to focus on the future trading relationship.
“We find that Sterling prices little Brexit-specific risk premium at the moment beyond its effect on monetary policy expectations. As a result, most of the upside for sterling is likely to arise from the more traditional channel of rate differentials rather than risk premium unwind,” adds Farmakis.
Farmakis and the UBS team flagged in a note Monday that the Pound-to-Euro rate could rise as high as 1.1764, up from its 1.1278 level on Monday, over the coming months if a transitional deal is agreed in good time.
“In our calculations for every 25bps of additional rate hikes priced in for the BoE vs ECB, EUR/GBP drops by c.2%. The repricing of the relative policy stance by a modest 25- 50bps is fairly plausible, in our view. Accordingly, sterling could gain by up to 4% vs EUR, implying a lower bound for EUR/GBP at c. 0.85,” Farmakis writes.
This translates into a Pound-to-Euro exchange rate of 1.1764.
The boost would come because the status-quo period of continuity that a transition would deliver, from March 2019 onward, would be seen removing significant economic risks from the table while also encouraging the Bank of England to raise interest rates again.
“The next few weeks, and prospects of a transition being agreed, will determine which side of the 0.85-0.90 range we trade in," says Patel of the recent range that has dominated EUR/GBP trading.
(This is a range of 1.1764-1.11 when looking at GBP/EUR).
"On the flip side – if we get some decent data – and a transition is still dangling as a near-term possibility (ie, there’s no Brexit breakdown in talks) then the BoE will likely crack-on with a May hike… and that’s not fully priced in yet so is a GBP positive story,” Patel wrote Monday.
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