Pound turnaround as May ‘backs down’ on Brexit debate

<p>What a difference a day makes, the pound is the top performer in the G10 on Wednesday, rising by more than 1.3% versus the euro, […]</p>

What a difference a day makes, the pound is the top performer in the G10 on Wednesday, rising by more than 1.3% versus the euro, and 1% versus the US dollar. The trigger was a surprise announcement from Prime Minister Theresa May that she will allow Parliament to vote on her plan to take the EU out of the European Union.

This will allow the UK’s elected representatives to scrutinize Theresa May’s plans for Brexit. It has triggered a relief rally in the pound on Wednesday, as it could potentially limit the prospect of a “hard Brexit” taking the UK out of the single market, which has been a major concern for some investors and the business community in recent days.

Is the GBP poised to stage a recovery?

The sharp decline in sterling on Tuesday saw GBPUSD dip to a low of 1.2090 (Bloomberg prices), a mere 200 pips above the low from Friday’s flash crash. This highlights the significance of Friday’s plunge in the pound: was it just a digital fat finger, or was it the market testing how low sterling could go? If it is the latter, then sterling could fall further, and today’s recovery may just be the pound bears pausing for breath.

Can the market price out some political uncertainty?

However, the significance of Theresa May’s decision to allow her Brexit plans to be debated in Parliament, could prove to be a soothing tonic for sterling in the medium-term. The recent plunge in the pound was triggered by fears that a “hard Brexit” could derail the UK’s economy and leave us without access to the single market. If Parliament can debate the plans, then the Prime Minister may have to soften her approach to negotiations, which could remove some of the market fears about the negative economic impact of Brexit.

From a technical perspective, the market will be looking to see if GBPUSD can return to its pre-flash crash levels, around 1.28. This is a tall order, since the pound has become a toxic currency for investors. Traders remain cautious, and even the overnight rally in sterling has even lost some steam as we move into the London session. Thus, the latest news that Brexit plans will be debated by Parliament may simply slow the pace of decline in the pound rather than spur a recovery. The market may want some concrete pledges that the UK will remain in the single market before the pound can fully recover.

The FTSE 100 slips back from record high

The FTSE 100 is also in focus today after it reached a record high yesterday. Crucially, the FTSE 100 didn’t close at the record high, and actually fell nearly 1% on Tuesday afternoon. Futures prices suggest that the FTSE 100 will fall by 10 points at the open. This is inline with a weak performance for US and Asian indices. The inverse correlation that we have noted between the FTSE100 and the pound suggests that today’s mini-recovery in sterling bodes ill for the UK stock index in the short term.

No new trends in view

We don’t think that today’s price action is the start of a new trend. There are many barriers to a pound recovery, including low interest rates from the Bank of England and strength in other currencies, such as the yen and the USD, where interest rates could rise in December. Likewise, we could see further gains in the FTSE 100, which isn’t looking particularly over-valued considering it has reached fresh record highs. We also need to wait for the UK earnings season later this month for further direction for the FTSE 100. If UK companies have managed to eek out profit gains in a difficult market, then the UK index could see further upside.

Overall, there is not much economic data to distract markets today, so we may see a continued recovery in the pound, and a short-term pull back in the USD. As we progress through the week, the markets are likely to focus on stock markets and Friday’s earnings announcements from JP Morgan, Wells Fargo and Citigroup.

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