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Sterling on Course for 18-month Lows against the Dollar warn BMO Capital Markets

© moofushi, Adobe Stock

- Pound Sterling set for further losses against USD.

- As Brexit talks go down to the wire, stoking fears of a "no deal".

- January could see the GBP/USD rate trading at an 18-month low.

Pound Sterling is on course for an 18-month low against the Dollar, according to analysts at BMO Capital Markets, who say "unresolved Brexit issues" will cause the British currency to underperform during the months ahead.

Sterling has already declined more than 5% against the Dollar in 2018 with around half of that loss coming inside the October month alone, as the Brexit negotiations appeared to hit another roadblock mid-month. 

However, that loss could easily extend in the months ahead if the December European Council summit passes without a deal on terms of the U.K.'s withdrawal from the EU being announced. 

Such a turn of events might see markets begin to panic that the U.K. is headed for the exit door without any subsequent "transition agreement" or arrangements in place for future trade. 

"The main issue now is that nothing the EU has offered British negotiators would be accepted by enough MPs to secure passage of the Withdrawal Agreement through the lower house. Previous plans for a special Brexit summit in mid-November have been shelved due to the lack of progress," says Stephen Gallo, European head of FX strategy at BMO. "For now, the risks of a “no deal/cliff edge Brexit” are increasing, and this should continue to weigh on the GBP."

A so called no deal Brexit would see the U.K. default to trading with the European Union on World Trade Organization terms. Many economists say this would be bad for the economy, but that the exact level of damage would depend on the extent to which trade flows are disrupted. 

A no deal Brexit that sees trade and commercial activity largely unimpeded would mean adverse economic consequences could be limited to another increase in inflation, a lot like the one seen after the 2016 Brexit vote, that simply depresses the value of real GDP for a period of time. 

However, that latter possible outcome would still see Pound Sterling sold by the bucket load on the currency market in what could easily become a repeat of the June 24, 2016 decline.

The sell-off on referendum night saw the British currency shed 17% of its value against the Dollar that year. A weaker currency lifts inflation by making imported goods more expensive to buy and can depress real GDP, which is economic output after accounting for inflation. 

"There is a final European Council summit scheduled for mid-December, where it’s possible to address Brexit issues if more progress is made," says Gallo. "We think unresolved Brexit issues will cause GBP to underperform the EUR slightly on a 3 month horizon. We target a move to 1.25 in GBPUSD in 3 months."

Disagreement over how to manage the Northern Irish border in the event a trade agreement is not reached at a later date is the main impediment to the conclusion of the current stage of the Brexit negotiations.  

The U.K. is due to depart the EU on March 29, 2019 but a so called transition period that is due to run from then until December 2020 will ensure nothing changes for a while after the exit date, assuming the Withdrawal Agreement and its "backstop" for the Irish border are agreed before then.

After the U.K. has left the EU the current plan is for both parties to enter talks about a possible future trading relationship. Although by then, the EU will have secured a number of binding commitments from the U.K. that will remove much, of not all, of the incentive for it to negotiate an alternative.

This, among other things, has been a significant bone of contention for Brexit-supporting U.K. lawmakers that has contributed to divisions, animosity and instability within the parliament in Westminster.

Gallo and the BMO team appear to envisage the Brexit talks going down the wire, certainly crossing over into January, given their target for Pound Sterling to sit at 1.25 on a three-month horizon.

We reported last week that strategists at Capital Economics are also bearish GBP/USD into year-end, warning that ongoing angst over Brexit negotiations should see Sterling remain on offer, eyeing a "big toll" on Sterling coming as betting markets increase their odds of a 'no deal' to about 50%.

The Pound-to-Dollar rate is quoted 0.68% lower at 1.2745 at the time of writing, ensuring it nurses a 5.7% loss so far in 2018.

It remains nearly 12% below the level it was at on the night of the June 23, 2016 E.U. referendum.

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