Sterling recovers as hopes for a Brexit deal are revived

LONDON (Reuters) -The pound rose on Tuesday as markets grew more optimistic a Brexit deal would be reached, even as implied volatility gauges pointed to further price swings ahead of the Dec. 31 deadline.

FILE PHOTO: UK pound coin plunges into water in this illustration picture, October 26, 2017. REUTERS/Dado Ruvic

Sterling dropped as low as $1.3135 last Friday when British Prime Minister Boris Johnson said a no-deal end to Britain’s transition period for trade with the EU was “very, very likely”.

But it rebounded as high as $1.3444 on Monday amid relief that negotiators agreed on Sunday to “go the extra mile” to try to reach a deal and the European Union’s chief Brexit negotiator said a deal was still possible.

The pound continued this trajectory on Tuesday, up 0.5% at $1.3397 at 1550 GMT, as traders waited for further updates on negotiations. Versus the euro, it was up around 0.5% at 90.75 pence.

It temporarily dropped, shortly before 1300 GMT, on news that Johnson had told the cabinet that no-deal was the most likely outcome, but soon recovered.

Commerzbank’s head of FX and commodity research, Ulrich Leuchtmann, said the pound was in “wait-and-see” mode.

“We have the potential that we still get a deal done before the end of the year. Therefore there’s no reason for a pound sell-off at the moment, but we have to wait,” he said. “Frankly, nobody expects anything in the next few days.”

Britain and the EU have just over two weeks left to negotiate a deal covering nearly $1 trillion in annual trade before Britain loses zero-tariff, zero-quota access to the EU’s single market on Dec. 31.

Speculative positioning on the pound turned net bullish in the week to Dec. 8, according to weekly futures data, suggesting the market is still optimistic about the chance of a deal.

But although sterling-dollar implied volatility gauges with a one-week maturity have dipped from their eight-month highs hit on Friday, they remain elevated, suggesting that further price swings are still expected in the short term.

“Our view is once again that a deal is firmly more likely than not, with the risks tilted towards full resolution by the end of the week,” wrote Deutsche Bank strategist Shreyas Gopal in a note to clients, adding that a Brexit deal would see sterling rally to around $1.36.

“Confirmation of a deal would remove one of the largest lingering risks for the pound, and should allow the market to at a minimum take out the increased negative rates pricing of the last few days,” he said.

The Bank of England meets on Thursday. Analysts say the risk of negative rates being introduced in 2021 depends on the impact of Brexit on the UK economy.

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