Brexit Return Pushes Sterling Lower

Sterling’s negative Brexit reaction continues

As was the case throughout 2017 whenever there was a lull in Brexit negotiations, the pound staged a rally as expectations grew that the settlement between the UK and EU would be favourable to the UK. Then as soon as the talks commenced, that optimism was thwarted, and the pound fell.

The agreement reached last December under which talks could progress to stage two produced a level of optimism that was wholly unwarranted, but it seemed that traders were determined to take the pound back towards and through the 1.4000 level versus the dollar. This was based on the fact that slightly optimistic noises were being made by Brussels.

There were rumours recently of a “Norway style” transition period in which the UK would continue to comply with EU regulations but not be able to affect the adoption of any laws.

Then yesterday, two blows were delivered, and the pound began its predictable fall.

First a Parliamentary committee questioned the legality of the Government’s Brexit legislation, commenting that it had fundamental flaws. This means that it is probable that the Bill will have to be redrafted.

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Transition terms released

Following a Eurogroup meeting, Michel Barnier, the EU Chief Negotiator set out Brussels terms for the transition period.

First, the transition period should run from 29th March next year until 31st December 2020. During that period the UK should abide by all EU regulations but have no standing within the EU to veto or alter any new laws that are passed. There will be no “cherry-picking” so free movement will continue. International agreements can be negotiated but cannot be implemented until after the transition period ends. Work is to continue to find a solution to the Irish border issue.

The pound reacted poorly to these two issues falling to a low of 1.4025 versus the dollar and 1.1343 versus the single currency.

Barnier’s comments came hot on the heels of UK Brexit Minister Davis Davis’s speech in which he had laid out the UK’s expectations for the transition talks. Davis most differed from Brussels in calling for the UK to have a say in new laws that had a direct effect on the UK. All Barnier could offer was a discussion over the UK possibly being allowed to participate on a case-by-cas basis.

The irrational expectations that transition talks could be concluded quickly and the stage two talks could commence as soon as early Q2 seem to have been dashed. The clock is now undoubtedly ticking and while there are no tangible reasons for a pessimistic view, a hard Brexit remains a possibility however unlikely

Euro correction continues as “big week” starts

There was a feeling late last week that the rise in the Euro which saw it reach 1.2538 versus a weakening dollar was overdone, particularly as it reached its medium-term target. That view has been proved right as the single currency has started to correct. The surprise that Mario Draghi didn’t feel ready to mention the timing of the reduction of the Asset Purchase Scheme was illustrative of the fact that any tightening of monetary policy was neither necessary nor timely.

His comments showed that the ECB are wary of any further currency strength choking off nascent economic growth in several of the region’s weaker economies.

The Euro fell to a low of 1.2336 versus the dollar although it did recover a little towards the end of the day, reaching 1.2379.

This will be an interesting week both in monetary policy and macroeconomic terms for the dollar. Wednesday sees the handover of the reins at the Federal Reserve from Janet Yellen to Jerome Powell which should usher in a more pragmatic but possibly less transparent period as Mr. Powell, a lawyer, favours evidence over proactivity.

Friday sees the release of the employment report with its attached volatility over the headline, but Powell’s attention will be drawn to the inflationary ramifications of wages growth.