GBP: Vanishing catalysts for sterling upside
GBP gains have stalled and we look for limited sterling upside from here. This is due to the uncertainty about Brexit and the passage of the Withdrawal Agreement Bill, and secondly because of the prospects of an early election. Modestly overvalued GBP can reverse towards EUR/GBP 0.8800.
Moving in circles
As we make clear in this: Brexit: What next if Parliament rejects an election?, our economists see a high hurdle for a UK election motion to be passed on Monday. Equally, the threat of a 'zombie' parliament, whereby the government effectively goes on strike, may not be overtly credible as it could reduce the Conservative Party's lead in the polls. This suggests moving back to the Withdrawal Agreement Bill (WAB) agenda, with the aim of translating the deal into law (albeit admittedly, the uncertainty about the next steps of the government is very high). Although the WAB has already recived a majority in parliament, the possible passage of amendments (for example, on the customs union or the transition period) and the subsequent loss of support among Conservative Brexitteers could mean that the majority for the Bill could disappear, despite it being passed earlier this week, so reversing any perceived progress.
Slowly vanishing catalysts for GBP upside
All this means vanishing catalysts for any GBP upside – given the declining odds of the WAB being passed and non-negligible odds of an early election or a zombie parliament. Our short term financial fair value model suggests that GBP is currently around 1.5% over-valued vs EUR (Figure 1), pointing to some scope for a reversal in GBP gains (towards EUR/GBP 0.8800) given the vanishing positive catalysts for the currency.
Equally, as the bulk of the positive Brexit newsflow seems to be in the price, European FX (both G10 and CEE) should stop benefiting – as was the case over the past two to three weeks (see Sterling’s high stakes game of snakes and ladders for the spillover from the Brexit newsflow into European FX).
Figure 1: After the recent rally, GBP is modestly overvalued vs EUR
The scale of GBP downside has been reduced
However, given that the odds of a hard Brexit have decreased compared to the state of affairs three weeks ago (before PM Johnson's latest attempt to reach a deal with the EU), we see GBP downside as more limited now too. We now see EUR/GBP 0.90 as the possible peak for the pair (vs 0.95 previously) if parliament fails to ratify the deal and we head into early elections – with the accompanying pre-election non-market friendly rhetoric.
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