Comment – Sterling – what next?

Volatility in the FX markets often hinges on uncertainty. With all the noise surrounding Brexit, which reached a crescendo over the weekend, it is therefore unsurprising that sterling has been subject to significant movements.

In the last 10 trading days, the pound has rallied from 1.11 against the euro to trade at 1.1650, a 5% gain. Meanwhile, against the US dollar we have seen sterling climb from 1.22 to 1.2950, a rally of 6%. This has been welcome news for UK importers as well as holidaymakers planning trips abroad.

There are two things here worthy of note. Firstly, despite the prime minister’s apparent progress on his journey to ‘get Brexit done’, there is still a long way to go. Yes, he deserves some recognition for persuading the EU leaders to drop the UK-wide backstop, but his true battle was always going to be on the domestic front. To win here he will need to convince MPs not only that this is the best resolution, but that it is the only one possible.

The second point to note is that a negotiated deal with the EU will bode well for the euro as well as for the pound. Sterling still remains heavily undervalued, however we would expect it to rally more strongly against the US dollar than against the euro. 1.20-1.25 in GBPEUR could quite easily be reached if everything goes swimmingly but 1.40-1.45 in GBPUSD is just as obtainable.

So what next for sterling?

So far, sterling has been well supported by a perceived reduction in the probability of a no-deal Brexit. Both parliament’s postponement of the meaningful vote and the prime minister’s letter to the EU requesting a delay have reinforced this sentiment.

Should parliament eventually vote in favour of the renegotiated withdrawal agreement, we would expect a further relief rally for the pound. On the other hand, a delay until January would mean more of the same uncertainty. This would put pressure on sterling and may even force the Bank of England’s Monetary Policy Committee to cut rates, especially given the recent weakening signs in the labour market and lower inflation. And then there is of course the potential for a general election. The prime minister’s strategy may work here, as he would be able to garner support from those who voted for Brexit along with those who feel a negotiated deal is indeed the right compromise.

It remains to be seen whether Mr Johnson’s success with the EU leaders will be matched on the home front. One thing that does seem certain is his desire finally to take the UK out of the EU as soon as he can. He now has some momentum and so too has sterling.

By Chris Towner, Director at JCRA