Sterling fell yesterday, retreating from a one-month high in the previous session as investors took profits from a brief rally spurred by hopes of a breakthrough in the UK’s Brexit negotiations.
But Brexit concerns still weighed on the British currency and, together with a broader market environment of risk-off sentiment, put it firmly on track for its fifth consecutive month of losses.
In late London trading, sterling fell a third of a percent to $1.2966, stepping further away from Thursday’s high of $1.3043, the highest since August 3. Against the euro, the British currency slipped to 89.71p, well below the 2018 high of 86.2p in April.
“Markets are getting a bit more optimistic about a breakthrough in Brexit negotiations though price action is far more cautious,” said Marc Ostwald, global strategist at ADM Investor Services in London.
British Brexit minister Dominic Raab said yesterday he was “stubbornly optimistic” Britain would reach a deal with the European Union on the terms of its departure from the bloc in time for an October meeting of EU leaders.
After talks with the EU’s chief Brexit negotiator, Michel Barnier, Mr Raab said he was “as confident as before, if not more” there will be a deal with the EU on Brexit.
After weeks warning of the growing risk of a damaging no-deal Brexit and signalling delay was expected if there is to be any Brexit deal, the EU’s strategy is now to highlight how close cooperation with Britain is possible after Brexit to make London more willing to accept divorce terms.
That is specifically the case for the sensitive issue of the Border between Ireland and Northern Ireland, where the EU wants a “backstop” solution in case of no deal, which includes terms that are anathema to London.
“We must have a detailed backstop solution, which is legally operational in the withdrawal agreement,” Mr Barnier said. “This backstop is critical – it’s essential to concluding these negotiations. With no backstop, there will be no agreement.”
Mr Barnier said the EU and UK were working for an “unprecedented partnership” in the future that would include a broad free-trade agreement, as well as sectoral cooperation deals in aviation, security and research, among others.
Foreigners’ net holdings of British government debt fell by a record amount last month, a move partly driven by a large volume of maturing bonds but one that also revived concerns about the effect of Brexit on investor demand.
Investors were wary of buying the currency aggressively as underlying economic weakness remained.
Britain has one of the highest current account deficits as a percentage of GDP in the developed world, and data this week showed companies growing more worried about a no-deal Brexit.
Markets will also be closely watching Bank of England Governor Mark Carney’s comments next week about the central bank’s decision to raise interest rates in August.
The past week has been marked with a number of dire warnings about what might happen if the UK crashes out of the EU without a deal.
Central banks holding sterling as part of their foreign exchange reserves could sell more than £100bn (€109bn) of the currency should Britain part company with the European Union without a trade deal, a Bank of America Merrill Lynch (BAML) study said.
BAML still expects a soft Brexit in which Britain retains customs access to the EU, and said reserve managers would likely await confirmation of a no-deal scenario before making a portfolio shift.
“This [no-deal Brexit] is not our base case, but we think central bank flows are an important source of flow which could determine whether sterling succumbs to a more protracted current account crisis,” the bank added.
Investec, meanwhile, said sterling will fall to 95p to the euro and approach parity in the early part of next year if a hard Brexit is still on the cards.
That view is based on a UK exit from the EU without a transition period or agreement on regulatory alignment and Britain leaving the EU customs union.
An alternative scenario, of an orderly transition, would boost the pound to 87p in the final quarter of this year and 88p versus the euro in early 2019, Investec thinks.
“The markets increasingly sense that the risk of no deal is greater. I don’t think anyone would really suggest otherwise,” Investec’s Aisling Dodgson said.
“At the end of the day, our baseline case is if you strip it down to fundamentals it’s in no-one’s interest for there to be no deal, but there are a couple of situations where you could see relationships breaking down,” she added. (Reuters)