Given the upcoming Brexit hurdles, what’s in store for sterling?
The long-awaited draft withdrawal agreement was unveiled last Wednesday, and for a fleeting moment, it felt like we were finally getting somewhere.
News that Theresa May had reached a deal pushed the pound up a notch against the dollar. But, as is often the case with anything Brexit-related, optimism was short-lived.
May’s deal was fiercely criticised, and everything lurched into chaos when two cabinet ministers, including Brexit secretary Dominic Raab, resigned – sending the pound into a spin. Last Thursday morning, sterling sank to $1.27 from $1.30 – a decline of 2.3 per cent in less than four hours.
Domestic stocks also took a hit, with the FTSE 250 tumbling by 2.7 per cent on Thursday. This is where we’re at so far, but what next?
Dogged determination
The political backdrop remains precarious, but David Cheetham, chief market analyst at XTB, says traders seem to be feeling more upbeat as May continues to cling to power against all the odds. The start of this week looked positive for the pound, rising to $1.28 during Monday morning.
While Cheetham admits that many business leaders would no doubt prefer an agreement with more favourable terms, the overriding feeling is that the deal is acceptable.
At the very least, it removes some of the uncertainty that has dogged the currency since the 2016 referendum.
While we should applaud May’s determination in the face of so much adversity, a lot could still go wrong. So it’s not really surprising that traders are taking a bearish attitude towards the pound, with implied volatility (how much sterling is expected to swing) now close to the most elevated levels since the referendum.
“Brexit chaos is the biggest circus of modern politics, and sterling is the poison pill,” says Naeem Aslam from ThinkMarkets, pointing out that speculators are biased for another sell-off.
Aslam argues that the worst days are ahead of us, largely because the chance of May staying on as a Prime Minister is small.
“Let’s just hope that there is only change in the leadership, and not change in the regime, or another election,” he warns.
Here are the major hurdles that the UK will have to face over coming weeks – and how each is likely to affect the value of sterling.
Kicked confidence
While May has held her ground and is evidently unwilling to throw in the towel, the question now rests on whether she will be forced out.
As of Monday, 25 MPs had publicly declared that they had submitted their letters of no confidence, but there’s still speculation about whether the numbers will reach the 48 threshold needed to trigger a leadership contest.
Brexit chaos is the biggest circus of modern politics, and sterling is the poison pill,” says Naeem Aslam from ThinkMarkets, pointing out that speculators are biased for another sell-off
Given that a contest hasn’t yet been called, the chances of this happening before Sunday’s EU Summit now seem slim. Again, this turn of events appears to have calmed some nerves, and has momentarily boosted confidence in UK companies.
Sealing the deal
The proposed divorce deal is expected to be signed off by the EU during Sunday’s Summit in Brussels, but the event will be yet another sticking point for the pound.
The Prime Minister is under pressure from MPs to negotiate further concessions with the EU. The question rests on whether the 27 other EU member states will agree to any changes.
Generally, though, it’s thought that the summit will not be a major hurdle. Ken Odeluga, market analyst from City Index, reckons that optimism will gain traction in the market between now and the House of Commons vote.
“During that time, elevated option pricing could weaken demand, and hence implied volatility could also ease,” he says.
House of cards
Even if the draft deal is rubber-stamped by the 27 member states during the Summit, the biggest hurdle facing the PM over the next few weeks is whether it will pass through parliament in December.
And given the widespread opposition from many MPs who think the agreement will leave the UK tied to EU rules, the deal is expected to hit a brick wall in parliament.
“We might have a deal to be voted through, but it still seems difficult to work out how it will get through parliament,” says Chris Beauchamp from IG.
“As a result, UK equities will continue to underperform. It has not been a sudden crash, like we had on Brexit day, but instead a slow drip-drip loss of confidence.”
If the deal is approved, it will no doubt prompt a surge in the pound, and boost shares in UK-focused firms. And if it’s rejected, there are a number of possible outcomes: May could renegotiate, we could end up without a deal, or we could face a second referendum – all of which look unfavourable for sterling and UK-focused companies.
However, if markets anticipate a no-deal scenario, the pound would be expected to sink to a low of around $1.20. At the moment, it looks like the market is not expecting this outcome and expects the UK to get a deal.
Simply put: while sterling might manage to avoid the rock-bottom lows seen in early 2017, hold tight because it’s going to be a bumpy ride.