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Pound holds its own as ‘no deal’ Brexit chances recede

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15 December 2020

Written by
Matthew Ryan

Senior Market Analyst at Ebury. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

The last few days have been highly volatile ones for the pound, with sterling traders hanging on every bit of news out of the latest Brexit negotiations.

A
s was always going to be the case, talks are going down to the very last minute with a little over two weeks to go until the end of the transition period. Markets had ramped up bets in favour of a ‘no deal’ late-last week after Boris Johnson stated that such an outcome was ‘very very likely’. The extension of Sunday’s deadline has, however, been greeted by a small sigh of relief among investors and provides a clear indication that a deal is there to be done.

Betting markets have gone from pricing in less than a 40% chance of a deal on Friday to around about a 70% chance of one as of this morning. This has been reflected in sterling, which is now back trading above the 1.33 level versus the dollar, having languished closer to the 1.31 mark a couple of trading sessions ago. With just two mains issues now said to be unresolved, our base case scenario is for a deal to be agreed by the end of the week, which would give both parties just enough time to vote on the agreement. While a deal is mostly priced in by the market, we would still expect a decent rally in the pound on the news, with a very sharp sell-off should it become clear that a ‘no deal’ was on the way.

What to expect from a busy week of central bank announcements

There are two major central bank meetings that could both shift markets in the next couple of days. First up will be tomorrow evening’s FOMC meeting. No major changes in policy are expected from the Fed this week, although we think that there is a chance that they could announce they are increasing the pace of purchases under the QE programme. The short-term outlook has deteriorated and the Fed may use this opportunity to further protect the economy from the downside risks posed by the recent surge in US virus cases and deaths.

The bank’s latest macroeconomic and interest rate projections will also be released. We will be looking for any signs that the earlier-than-expected roll-out of vaccines may cause growth to the surprise to the upside or bring forward the timing of future interest rate hikes. The US dollar appears oversold following its recent sharp move lower, so any hawkish surprise from the Fed on Wednesday could trigger a decent short covering rally.

Then, on Thursday, the Bank of England will be announcing its latest policy decision following the MPC’s December meeting. Again, we don’t envisage any change in policy, particularly given Brexit talks are continuing to drag on. We think that the bank will voice its concerns over the possibility of a breakdown in negotiations and the tighter restrictions that have been brought about by the second wave of virus infection. As with the Fed, we also think that the BoE could strike an optimistic tone towards 2021, given that the vaccine roll-out has already begun in the UK.

This week is also a very busy one in terms of macroeconomic data. Wednesday’s Euro Area PMI numbers will be very closely watched by investors, as will tomorrow afternoon’s US retail sales numbers. Friday’s UK retail sales could also shift the pound, although it is likely to be largely overlooked in favour of Brexit headlines.

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