Sterling tumbles on hard line positioning

05 Aug 2019

Chris Brand

Senior FX Trader

The Sterling had a bit of a break when Boris Johnson was elected. But since then, the action has all been one way. 

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Boris’ latest call is for the UK to prepare for a no-deal Brexit if the EU won’t move on the backstop plan for the Irish border. This risks hardening negotiating positions on both sides.
Johnson’s rhetoric may be just a negotiating tactic to ramp up the pressure to get movement from the EU. But if he fails, I think it’s going to be very difficult to force a no-deal Brexit through Parliament. 

Market positioning

Markets seem to be adjusting to the perception that the risk of a no-deal Brexit has increased and this is supported by the government putting real money into it. It is reported, incoming Chancellor Sajid Javid is allocating £2.1 billion for no-deal preparations and is looking for an additional £138 million to spend on advertising to win public support.
Tories are pulling ahead of labour in the polls
The hardliners may have also been encouraged by the ‘Boris bounce’ because the Tories are suddenly polling 10% ahead of Labour. Obviously, some people are buying into it. But I’m finding it hard to see this media offensive shifting votes in Parliament, where the numbers have not previously been there to push through a no-deal Brexit.
I believe sellers of sterling were always looking for a bounce on the view that Johnson could get a deal through. That didn’t last long. Sterling buyers, meanwhile, seem to have no good reason to go long sterling because it now looks like sterling weakness is going to continue. 
I think people will start to get worried if sterling breaks below $1.20, which would be a big headline-grabbing number. 

Interest rate policy

The Bank of England is, of course, watching events closely, but looks unlikely to do anything soon. I think they’re in a difficult position because if they cut rates now and a Brexit deal is agreed, they’re going to have to answer for that when the pound recovers.
I suggest it’s best to let the Federal Reserve and ECB cut their interest rates and address matters later. A hard Brexit would clearly justify cutting rates, even if the pound continues to fall, if only to take away some of the initial shock to the economy. But without clarity, it’s hard to see them doing anything. 
Avoiding a cliff edge should spark a move higher for the pound. But if Boris Johnson continues to paint red lines as his predecessor did, it isn’t going to help.

Rational behaviour

I think it’s important to underscore that the currency shifts we're seeing are legitimate, understandable price adjustments. If a favourable deal is agreed, you're almost certainly going to see the sterling move higher, at least initially. Whether that's sustained or not will depend on how the agreement affects the UK’s long-term growth outlook.
Avoiding a cliff-edge should spark a move higher for the pound. But if Boris Johnson continues to paint red lines as his predecessor did, it isn’t going to help.

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