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Pound offers 'sizeable' potential from softer Brexit

By Oliver Haill

Date: Wednesday 16 Jan 2019

Pound offers 'sizeable' potential from softer Brexit

(Sharecast News) - The pound's reaction to Theresa May huge defeat in the meaningful vote on her Brexit deal was muted on Wednesday, with investors and analysts trying to decipher the political runes for the best way to make a buck.
Shifts in sterling, which was up 0.1% versus the dollar at 1.2873 and 0.2% against the euro at 1.1290, were small as a defeat had already been priced in by the market and the risks of a Conservative leadership contest had been removed in December.

While the Labour Party has tabled a vote of no confidence, the market is confident that the government will win and the pledge by the Prime Minister to report back to parliament on the next steps in the process and work on a cross-party solution provided further support for the pound.

There remains scope for "sizeable GBP appreciation", BofA Merrill Lynch forex strategist Kamal Sharma said, "once political risk premium priced out". That's some hope.

Sharma said it was "clear from the scale of the defeat" that minor tweaks to May's plan will not suffice, particularly as the EU have stated they are unwilling to reopen the EU Withdrawal Agreement.

"The government still has options, but in our view, the most likely scenario in the coming weeks is an extension of Article 50. Furthermore, the PM's suggestion of a cross-party approach to a solution suggests all paths lead to a soft Brexit, our long stated position," he added.

SOFTER BREXIT OR NO BREXIT

Goldman Sachs was standing by its base case that a "close variant of the current Brexit deal will ultimately command a majority in the House of Commons", but said that Tuesday's developments "skew the risks to that base case further towards a softer, later Brexit - or no Brexit at all".

As all the different paths seem likely to be opposed by different sections of parliament, HSBC's economists suggested that perhaps "the most neutral thing" the Commons could agree would be an extension of Article 50 negotiations. "This is allowable by the Lisbon Treaty, and although some EU27 states may be reluctant to extend, we think it would ultimately be acceptable, perhaps with some conditions. One condition might be that the UK specify a clear way forward."

An extension to Article 50 was, for Credit Suisse, "highly likely" and would be a "positive development as it would avoid a cliff edge Brexit at the end of March".

May's statement that she will attempt to find common ground, through a process of cross-party discussions, should yield a soft Brexit outcome, Credit Suisse's Sonali Punhani said, though will "take time and political uncertainty and stress".

Not least, it risks increasing tensions with the anti-EU Conservatives, "and may impair PM May's capacity to govern", Punhani said, however, she thinks crashing out with a no-deal Brexit "is the least likely outcome as there is a parliament majority for avoiding a no deal Brexit".

Morgan Stanley saw a "low risk of a no deal" but had "little conviction on which of the alternative options - referendum, the current deal or early elections - will be chosen". Greater clarity is expected by early February, "before parliament runs out of time to hold elections before Brexit, assuming that the EU will only agree to a delay once the UK has made a decision on the way forward".

TIME TO BUY THE POUND?

Whether it is "time to buy" sterling was examined by Rabobank forex strategist Jane Foley.

"Going forward the confidence of GBP bulls is likely to be sapped if there is little near-term progress in finding a Brexit compromise and if there is no effort to push back the exit date on March 29. Confirmation that the Brexit start date is set to be delayed would send a strong signal that parliament is not prepared to send the UK over the cliff edge without a deal being first in place."

She said this could be sufficient to create a "sizeable" sterling rally, though a delay would also imply further uncertainty about the shape of Brexit deal, while the fact that talks about the UK's EU future relationship are set to extend for another two years after the start of Brexit suggests the pound "has a long way to go before it finally shakes off the mantle of political uncertainty".

In the near-term, Foley sees potential for EUR/GBP to pull back to the 0.87 area, and potentially below, if it is confirmed that May will seek a cross party compromise and push back the start date for Brexit.

Once the no confidence vote is out of the way, the market will then turn its focus to Plan B next week and, Nomura reckons GBP "will likely continue to make gains" as "the market views Parliament to have a softer Brexit majority and one that is also against a no deal Brexit".

Nomura has re-entered its short EUR/GBP position at 0.8880, saying: "We do not enter such a position lightly; it was a difficult decision to make as the risk of a loss tomorrow for the government would send GBP lower substantially. But for the time being we believe the market will be looking toward softer Brexit outcomes and GBP will benefit as a result."

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