markets

Pound investors see May giving in to EU to break Brexit deadlock

Strains have grown between the two sides in the Brexit talks

Bloomberg
16:59 March 4, 2018

London

As the risk of another deadlock in the Brexit talks rises, pound traders seem to have seen it all before.

With just weeks before a key summit, when the UK wants the European Union to agree to a transition period following Brexit, sterling options aren’t showing an increase in demand for volatility hedges amid a ratcheting up of tensions between London and Brussels. Some analysts see a last-minute deal, similar to December’s agreement to move talks onto trade, while expectations of an interest-rate increase from the Bank of England are supporting the pound.

Strains have grown between the two sides in the Brexit talks, with UK Prime Minister Theresa May saying that no one in her position could ever agree to the draft treaty published by the EU last week. May is seeking to get the EU to sign on to a transition phase — critical for businesses — at the summit of leaders later this month, but Michel Barnier, the bloc’s chief Brexit negotiator, has warned that any such agreement could still unravel before Britain’s scheduled exit in March 2019.

“We only have to remember what actually happened in December, brinkmanship and a climbdown by the May government,” said Liam O’Donnell, a money manager at Aberdeen Standard Investments. “Given the fact that the harder Brexit is now coming increasingly under threat, one could argue that significant sterling weakness is less likely over the longer term.”

May’s room for manoeuvre has been increasingly squeezed by both domestic politics and an uncompromising EU, prompting some to speculate about a collapse in her administration. However, the same factors causing commentators to worry about May’s leadership may also be working in the pound’s favour, with analysts at banks including MUFG, Societe Generale SA and Rabobank saying they expect May to back down and reach a compromise with Brussels, which could lead to a softer and more business-friendly Brexit.

Conciliatory Tone

May seemed to strike a conciliatory tone in a speech on Friday, saying that neither Britain nor the EU will be able to get exactly what they want in the talks and giving the impression she’s prepared to put commercial interests and jobs ahead of ideology. Still, with the two-day EU gathering starting on March 22, Barnier has said talks must be accelerated if they are to be successful. Yet pound watchers don’t appear to be too ruffled by such threats.

“The upcoming EU leaders summit is still seen as an important event,” said Lee Hardman, a currency strategist at MUFG. “It had been hoped a transition deal could be agreed by then, at the same time if it takes little longer, it’s not the end of the world. We’ll have more clarity in the coming weeks.”

In the meantime, it’s not just Brexit that pound investors have to consider. The prospect of a rate hike from the BOE in May, as well as the bearish dollar view among some market participants, mean it may still make sense to bet on the UK currency despite the risks.

“The market has to balance between the possibility of BOE rate hikes in coming quarters and growing concerns about Brexit,” said Alvin Tan, director of currency strategy at Societe Generale. “It has been whipsawed by countervailing factors in sterling.”