Pound Greets Historic Deal With a Whimper as Economic Woes Brew
(Bloomberg) -- For nearly half a decade, the pound has been whipsawed by Brexit negotiations -- yet news that a trade deal has been reached saw sterling curb its advance.
It was up 0.3% against the dollar to $1.3534 as of 6:25 p.m. in London, having earlier risen as much as 0.9%. Much of the optimism is already baked in, with the currency nearly 10% stronger since the end of June and the relative cost of hedging pound weakness over the next year at its lowest since March.
The coronavirus and the country’s grim economic outlook have also muscled in on Brexit’s influence, while investors say the limited scope of the agreement -- which won’t apply to the financial industry and the services sector -- caps benefits for U.K. assets.
“The reality is that a deal -- while good news in isolation, avoiding tariffs etc. -- does not compensate for trade frictions while the U.K. suffers disproportionately under Covid restrictions due to the importance and significance of the service sector,” said Jeremy Stretch, the head of Group-of-10 currency research at Canadian Imperial Bank of Commerce in London.
A trade deal avoids a worst-case scenario for the U.K. economy, which would see it become subject to World Trade Organization terms. That would have ended decades of free movement in people, goods, services and capital and see a near-term drop of around 1.5% of gross domestic product, according to Bloomberg Economics.
Yet the economy is reeling from the coronavirus pandemic. Growth is still forecast to be 0.5 percentage points lower every year for the next decade than what it would’ve been had Britain stayed in the bloc, according to Bloomberg Economics.
“Brexit was for the most part very draining for U.K. investors but in the grand scheme of things it wasn’t a big deal,” said Mark Nash, head of fixed income alternatives at Jupiter Asset Management, who sees the pound rising as oversees investment returns. “The U.S. and China and the coronavirus globally have been the key drivers. This changes little but it’s good to move on from it, mostly for sanity reasons.”
Thursday’s muted reaction contrasts with the day after the referendum in June 2016, when the pound fell as much as 11% on Britain’s shock decision to break with the European Union. That’s not say traders are ignoring the headlines: sterling rose as much as 1.6% on Wednesday on optimism for a deal.
An accord is “temporarily bullish for sterling, but we think that most of the good news is in the price and suggest taking profit around $1.36,” Sheena Shah, currency strategist at Morgan Stanley, said before the announcement. “The many uncertainties for the pound -- local and global -- lead us to expect it to be an underperformer for most of 2021.”
|Pound Levels to Watch:|
Shah sees the euro-pound cross, which fell 0.4% to 0.8997, at 0.9500 by the end of 2021. Jane Foley, head of foreign-exchange strategy at Rabobank, said in a note earlier this week that the pair will struggle to push below 0.88 in the coming months due to a combination of a “skinny” trade deal and an increase in coronavirus-lockdown restrictions in the U.K.
That’s why this week’s real drama came on Monday, when the pound fell 2.5%, the most since March, after a mutation in Covid-19 threatened the U.K.’s supply chains. But also, liquidity is diminishing as Christmas draws near.
Manuel Oliveri, a foreign-exchange strategist at Credit Agricole SA, said participation may be low because many clients have already closed their books for the year.
“It’s Christmas Eve and markets just may not be paying that much heed,” said Ranko Berich, head of market analysis at Monex Europe. “The U.K. has other serious macro issues.”
©2020 Bloomberg L.P.