Pound Drops, Gilts Advance as Brexit Transition Seen at Risk

(Bloomberg) -- The pound fell to a three-week low against the dollar and U.K. government bonds rose as the European Union’s chief negotiator warned a Brexit transition period for the U.K. was not guaranteed.

Sterling slipped versus all of its Group-of-10 peers and gilt yields dropped across the curve after Michel Barnier’s comments, which followed the release of the EU’s draft Brexit treaty that saw the bloc ignore several of Britain’s demands, potentially complicating the country’s exit. U.K. Prime Minister Theresa May said in response that no British leader could accept such a deal.

With its draft treaty, the EU is seen to be ignoring U.K. demands for a longer Brexit transition period -- seen as vital for British businesses -- and a key compromise Britain seeks on the land boundary with Ireland. Withdrawal talks must be accelerated if they are to be successful, Barnier said on Wednesday, adding that Northern Ireland must follow EU rules to avoid a controversial hard border with the rest of the island.

“The most important point made by Barnier is that there are no guarantees on the full access to the single market throughout the transition period if any of the obligations are violated,” said Andreas Steno Larsen, global currency strategist at Nordea Bank AB. The EU seems to be saying “take it as it is, or there will be no transition deal,” and “the market seems to agree sending euro-sterling higher.”

Sterling Slumps

The pound fell as much as 1 percent to $1.3775 as of 3:52 p.m. London time, its lowest level since Feb. 9. It weakened as much as 0.7 percent to 88.54 pence per euro. The yield on 10-year U.K. government bonds fell five basis points to 1.51 percent.

With May due to give a speech on Friday, investors will be eyeing her words for signs of how much she is willing to compromise with Europe. At least ten lawmakers in her own party are now prepared to demand the U.K. participate in a customs union after Brexit, while Barnier suggested on Wednesday that keeping the current customs arrangement would go some way toward solving the Irish border issue.

“It’s hard to talk about the positives at this stage for the pound,” said Jordan Rochester, a currency strategist at Nomura International Plc. “It is unclear if Theresa May has the political capital to concede to the EU’s demand of European Court of Justice oversight and citizens rights’ during the transition, so a lot does hinge on what direction she decides to take in Friday’s speech.”

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