Pound's Rally Vulnerable to Fickle Brexit Sentiment: Macro Week

(Bloomberg) -- The pound’s rally against the euro this week, spurred by greater optimism on the Brexit talks, may be vulnerable to fast-changing sentiment toward the negotiations as investors look ahead to the factors that may drive moves in the currency pair in 2018.

Sterling was set on Friday for its best week in more than two months against the common currency following signs that the impasse on the U.K.’s divorce bill to leave the European Union may break as soon as mid-December. Some markets participants expect the two sides will agree at the next EU summit on Dec. 14-15 that significant progress has been made, and a move to the next phase of beginning to discuss trade is round the corner.

In addition to pound-positive news, euro-area inflation data came in lower than expectations, sending the cross to an almost one-month low of 0.8777 on Thursday before paring losses and rising back above 0.8800.

Strong support above 0.8750 and lighter positioning helped the common currency rebound, according to Europe-based traders, who asked not to be identified as they aren’t authorized to speak publicly.

The euro has been consistently trading above 0.8700 versus the pound since June and a meaningful drop below would maybe need more than just progress on a Brexit bill settlement. While the sensitive question of the Irish border still remains unresolved, it is mostly what lies ahead at the next phase of the U.K.-EU negotiations that should be troubling pound bulls.

The real fight begins when trade talks get in the picture as a tailor-made deal for Britain may be very hard to get. In German Chancellor Angela Merkel’s words, the next phase of talks will be “incomparably more difficult than the first stage.”

Amid a strong euro-area economy and lingering long-term concerns about the Brexit process, option traders look for increasing upside risks in the euro-pound cross, as shown by risk reversals.

Sterling rallies this year have gained traction as some medium-term stale shorts hit their trailing stop levels and rushed for cover. Short-positioning in the U.K. currency is bound to be less crowded: the Bloomberg Pound Index’s advance since its August low touched 6 percent on Friday.

U.K. data were soft in November and a turnaround is needed for the pound to be able to buck a trend that sees it weakening versus the common currency as the last month of the year kicks in. Pound bulls should keep in mind that when it comes to Brexit-related gains, it may be a case of easy come, easy go.

What to Watch

  • On Dec. 4, U.K. Prime Minister Theresa May is to meet with European Commission President Jean-Claude Juncker and EU chief Brexit negotiator Michel Barnier as they seek the outline of a deal that could pave the way for a breakthrough at the December summit
  • U.K. Brexit Secretary David Davis addresses a Brexit parliamentary committee, while Chancellor of the Exchequer Philip Hammond speaks in front of lawmakers on the Treasury Committee on Dec. 6
    • The 28-member College of Commissioners, which provides the European Commission’s political leadership, discusses Brexit and will likely make its recommendation on whether sufficient progress has been made to move negotiations onto the future relationship the same day
  • Germany’s Social Democratic Party holds a convention in Berlin that’s expected to vote on endorsing coalition talks with Merkel
  • On Friday, Dec. 8 the next U.S. employment report takes center stage
    • By then, U.S. Congress must pass a spending measure to avoid a partial government shutdown; another stop-gap bill that puts off hard funding choices for two more weeks eyed
  • RBA meets on Dec. 5; euro-area GDP, U.K. services PMI due; to see data calendar, click here

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