Pound Surges, Gilts Slide on Signals of Brexit Breakthrough

(Bloomberg) -- The pound surged on signs that the U.K. is inching closer to an agreement with the European Union on a Brexit divorce deal.

The currency climbed to the strongest level since April versus the euro after a report that negotiators have agreed on an Irish border backstop, a key sticking point in the talks. Prime Minister Theresa May will hold a Cabinet meeting Wednesday to discuss a draft Brexit agreement, and a summit with the EU could occur as soon as Nov. 25. Gilts declined as conviction grew that the Bank of England will raise interest rates next year.

Pound Surges, Gilts Slide on Signals of Brexit Breakthrough

The currency bounced in response to a “breakthrough in the Brexit negotiations,” said Valentin Marinov, head of FX research at Credit Agricole SA. “What remains to be seen is whether the U.K. Cabinet will agree to the proposed text.”

The pound rose as much as 1.5 percent to $1.3047 before paring gains, and reached 86.56 pence per euro, the strongest level since April 18. The yield on the U.K. 10-year government bond increased nearly seven basis points to 1.52 percent. In money markets, short-sterling implied yields climbed, a sign traders may be raising bets on rate increases by the central bank, should a Brexit deal be concluded.

Even if the Cabinet signs off, the agreement would need approval from parliament, where May faces a stiff challenge. And while the body may approve a withdrawal by March, the pound could suffer some whiplash on the way, Wells Fargo currency strategist Erik Nelson and economic analyst Abigail Kinnaman said in a note to clients. If that scenario plays out, the pound-dollar rate could near $1.34 in six months and $1.40 in a year, they said.

“We see potential for a rally (around 1%) in the pound once a withdrawal deal is finalized by the EU and U.K. and then another, larger, rally (perhaps 2-3%) once that deal is ratified by parliament,” they wrote, referring to that base-case scenario. “The period between the initial deal being reached and the subsequent ratification by parliament will likely be marked by ongoing volatility and uncertainty, which could see the pound retrench.”

In the case of a “no-deal” Brexit outcome, Nelson and Kinnaman see the pound falling nearly 8 percent against the dollar and 6 percent against the euro.

May doesn’t have a majority in parliament and faces opposition from Labour Party lawmakers. She also has to appease some of the hard line Brexiteers within her Conservative party.

Some were quick to criticize the deal. The Democratic Unionist Party’s Sammy Wilson said the deal, as reported, would be voted down, and pro-Brexit Conservative MP Jacob Rees-Mogg said the Cabinet shouldn’t support the pact. Boris Johnson also said he’d vote against the deal, though acknowledged that neither side wants a no-deal outcome.

Earlier Tuesday, Irish broadcaster RTE cited an unidentified senior official as saying that the key part of the Withdrawal Agreement had been agreed. Still, the official said it would be wrong to say that negotiations were concluded. Irish Prime Minister Leo Varadkar declined to comment on the report. The Telegraph newspaper also reported that the two sides had agreed on the text of a divorce deal.

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