Why Pound Traders Are Optimistic About Brexit
(Bloomberg Opinion) -- Hope springs eternal. U.K. Prime Minister Boris Johnson is packing his bags for Brussels to meet with European Union leaders as the fraught Brexit trade deal talks shift from technical negotiations to the endgame political haggle.
That he’s prepared to risk the political embarrassment of traveling and coming away empty handed ought to indicate that the British side wants an agreement. Pound traders still want to believe a deal will de done.
Sterling fell sharply on Monday morning because of suggestions that the gap between the Brits and the European Union was just too vast. But it recovered ground steadily, and ended the day largely unchanged from Friday, even after Johnson and European Commission President Ursula von der Leyen said big differences remained on the three issues of fair competition, fishing and governance of a deal. That they are still talking was enough to support the currency. Pound pessimists have been squeezed relentlessly since March’s low of $1.14; it has risen 17% since then.
There are plenty of doom-mongers still around, but sterling is fundamentally undervalued so there ought to be modest further upside if a workable deal can be struck. Removal of a lingering Brexit handbrake ought to encourage foreign investors who’ve been significantly underweight on their U.K. exposure. If the no-deal cloud lifts, combined with an earlier than hoped for vaccine solution, then the British economy could easily grow by 6% or more next year. A no deal would strip about 1.5% from that outcome, according to Bloomberg Economics’ Dan Hanson.
Admittedly, if Johnson does return with an agreement this week (and there are fears we may just get more delay), it will look very skinny compared with full EU membership. Either way there will be border disruptions and confusion — which goes with any major realignment left to the last minute — so sterling probably won’t race much beyond $1.40 with a deal.
You might get a sharp fall in the event of no deal to below $1.30, but that may not last as the negatives are largely priced in already.
Sterling’s fate is less dependent on Brexit shocks than Covid recovery, which is the stronger short-term force. Third-quarter U.K. growth of 15.5% shows there’s some vigor left in the economy. Interest rates are near zero, the Bank of England’s bond-buying arsenals are fully loaded and Chancellor of the Exchequer Rishi Sunak and the BOE are primed for more coordinated fiscal and monetary stimulus.
The severity of a no-deal scenario is also debatable. Although those three political stumbling blocks remain, the technical work is complete. There are quick side deals to be done that will check the economic fallout. Both sides have been careful to leave doors open. Unless there’s a total breakdown, cooler heads should prevail.
It will take a lot to bring the pound out of its four-year range to the euro. The EU has problems of its own — with economic recovery just as patchy. Its next seven-year budget and pandemic recovery fund still aren’t approved.
The euro and the pound are also being supported by the the dollar’s downtrend, with the greenback falling to its weakest trade-weighted level for over two years. That’s a bigger problem for the the euro zone’s export-dominated economies, and the European Central Bank will add further huge stimulus at Thursday’s governing council meeting.
Johnson knows he has to rebuild trust with Brussels and his European counterparts. Signaling that he will put aside contentious clauses in upcoming domestic legislation, which would undo some of the Brexit withdrawal agreement, was a start.
If he’s to repeat his breakthrough of a year ago, when a walk in a Cheshire hotel garden with then Irish leader Leo Varadkar sealed the withdrawal deal, he’ll need to give some ground again while keeping his own party’s Brexit purists at bay. Johnson has always viewed himself as a lucky general; for now the infantry of sterling traders is just about with him.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.
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