Sunday bloody Sunday
Sterling underperformed in September, in line with our bearish forecast (UK & Sterling facing potential quadruple whammy, 4th September 2020). It gradually recovered from 22nd September, appreciated throughout October and peaked on 27th November.
Sterling NEER has since weakened about 2.4% to an 11-week low. The sell-off at the turn of December was exacerbated by all four of the United Kingdom’s devolved nations still being subject to tight social distancing restrictions and their negative impact on the UK economy.
In the past ten days the dwindling odds of the United Kingdom and European Union signing a free trade deal before 31st December have driven Sterling’s sharp fall – a risk we flagged over three months ago.
About 90% of a draft treaty has been nailed down but many clauses are still subject to a broader agreement and negotiators are still at loggerheads on a number of key issues, including the EU’s fishing rights in UK waters, “level playing fields” and the role of the ECJ.
Senior officials met on 9th December in a last-ditch attempt to reach agreement but little or no progress was made. Both sides have agreed that a deal needs to be reached by Sunday 13th December. This is now a “hard” rather than “soft” deadline, in our view.
Both sides have warned in the past 48 hours that agreement on a new trade deal by Sunday is unlikely and the EU has published contingency measures in the event of a no-deal.
A “hard” Brexit would have a material negative impact on the UK economy in the short-term, according to our analysis, and we would expect Sterling to weaken further, particularly as net short speculative positions are still modest.
We still think a free-trade deal (“soft” Brexit) will be reached but our degree of confidence has sharply eroded in recent weeks. A Sterling rally could still be hostage to “devils in the detail” of such a deal and to the weak near-term outlook for an economy on the back-foot.
Finally, while mass vaccination is a game-changer medium-term it does not preclude a further tightening of UK social distancing measures in coming weeks, in our view.
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Olivier is an economist and rates & FX strategist with over 22 years experience in financial markets. He is Director and Founder of 4X Global Research, an independent, London-based consultancy which provides institutional and corporate clients with substantive research, high-quality analysis and insight on emerging and G20 economies and financial markets.