It is no surprise the Brexit newsflow continues to dictate sudden fluctuations in the British Pound. Although what is surprising is that despite there being less than six months remaining before the United Kingdom is scheduled to leave the European Union with minimal confidence a Brexit deal is close, investors still refuse to price into expectations that there is a potential eventuality of a hard-Brexit.
The British Pound trading close to 1.32 at time of writing provides memories of recent history where investors have been caught off-guard by political risk events. The historic outcome of the EU referendum springs to mind as an example of this and with the clock ticking fast until the deadline for a Brexit deal, investors should be more aware of potential downside risks to the Pound.
At the moment, investors seem to be content with optimism that a Brexit agreement will eventually be struck. I think we just need to look at the events following the recent meeting in Salzburg and the defiant comments made by UK Prime Minister Theresa May after the summit to recognize that any optimism that a deal is close should be faint.
Even if a breakthrough in Brexit negotiations is eventually struck, the upside potential in the British Pound is limited to around 5%. This is low in comparison to how fast the Pound could crash if a hard-Brexit is the eventual outcome. The Pound is at risk to crashing back down to the lower 1.20’s if investors become frightened over a hard-Brexit.
There are no shortages of reasons for investors to hold negative views on the British Pound. The assertive comments from Theresa May following the failed Salzburg meeting that no a Brexit deal is better than a bad deal heavily highlights how strained UK and EU relations have become during the long-winded negotiations. The EU is obviously not wanting to provide UK officials with any favors to prevent other populist parties around Europe gaining encouragement from leniency shown towards the UK, suggesting that Theresa May will continue to struggle against EU officials.
What is also not supporting Theresa May in her quest to secure a Brexit deal that is fair for those who voted to leave the EU two years ago is the ongoing and relentless speculation over her position remaining at threat to a potential leadership challenge. Reports over another potential UK election refuse to go away and investors need to see stability with leadership positions at a time where it is common knowledge that the UK will go through a period of uncertainty. The potential for a hostile Tory Party Conference for Theresa May in early October might provide encouragement for investors to take profit on Pound positions.
All of the above doesn’t mean that there is no positive news out there for the Pound. The problem with current valuations is that investors are not positioned, or prepared at all for a potential hardBrexit shock. Positive news for the Pound includes the continuation of UK economic data defying worrying forecasts of what the outcome for the UK economy would be following the EU referendum shock, and the probability that the Bank of England will remain ahead of the European Central Bank and Bank of Japan (when it comes to providing guidance on the possibility of higher interest rates.
The technical outlook for the GBPUSD is somewhat conflicted by how suddenly the Pound can shift in direction due to sensitivity around Brexit newsflow.
1.30 in the GBPUSD will continue to act as a strong psychological level for investors. Ambitious investors might continue to use the 1.30 level in the Pound to drive the currency towards 1.32/1.33. The pair would need to conclude above 1.33 on a monthly basis to instill confidence that the GBPUSD can rally above 1.35 on a Brexit agreement outcome.
Otherwise, and while Brexit uncertainty remains, selling rallies in the British Pound will be tempting for investors. A technical close below 1.30 would signal the potential for further declines in the Cable.
