Pound Falls as Brexit Negotiators Warn of Trade-Deal Obstacles

(Bloomberg) -- The pound halted a four-day winning streak Friday, as Brexit negotiators warned major differences remain with less than two weeks to go before the U.K. and European Union must strike a new trading agreement.

The currency was down 0.5% to 1.3520 as of 2:05 p.m. in London, after earlier dropping as much as 0.7%, making it the worst performer among G-10 currencies. Before Friday, sterling had gained 3% this week on optimism a deal could be reached.

Britain’s chief negotiator David Frost said that progress in the talks has been blocked, and European Commission President Ursula von der Leyen warned that the two sides still face big obstacles, particularly on fishing, that may prove insurmountable.

“Differences do remain and this has knocked the GBP off its perch,” said Jane Foley, head of FX strategy at Rabobank. “That said, as long as talk continues, the market will be hopeful that there is a deal to be done -- albeit a skinny one.”

Latest options data show traders taking upside exposure in the pound, spurred either by optimism about the ongoing talks, or the relative cheapness of the contracts. Since Monday, out of a total of 15.9 billion pounds notional on vanilla options, demand for calls stood at 10.2 billion pounds, or 64%.

Behind the scenes, negative language is to be expected at this stage, according to officials in Brussels, both as a negotiating tactic and to manage expectations at home. On Thursday, the European Parliament set officials a Sunday deadline to reach a deal.

If the two sides don’t succeed by next week, it’s likely negotiations will continue to go down to the wire ahead of the hard Dec. 31 deadline, when the transition period officially ends.

“Talks could go to New Year’s Eve. That’s what market participants are probably now expecting, hence the limited FX reaction to this latest worsening in optimism,” said Derek Halpenny, head of global market research at MUFG. “Market fatigue over these negotiations has clearly set in with a sense that this again is simply brinkmanship.”

If the U.K. leaves the bloc with no new trade agreement in place, decades of free movement of goods, services, people and capital will come to an abrupt end. Such an economic shock could require further support from the Bank of England including negative interest rates, according to BofA Global Research.

BOE policy maker Gertjan Vlieghe said Friday that the central bank should be prepared to add monetary stimulus including negative rates to complete the economic recovery from the pandemic.

Money markets brought forward bets for a BOE rate cut, pricing 10 basis points of easing to 0% in March 2022 compared to 9 basis points earlier Friday. U.K. bonds extended gains, with the 10-year yield falling five basis points to 0.24%.

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