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Market Analysis
Sterling Lifted by Soft Brexit Tease

by David Starkey | December 2, 2016

– Sterling/Euro higher for 5th consecutive week

– Sterling up 5% from flash crash lows

– Choppy seas for EUR with Italian constitution vote & ECB

 

Sterling edged higher this week following comments from the UK’s lead Brexit negotiator David Davis that appeared to soften the government’s previously firm stance on a so-called “Hard Brexit.” During parliamentary proceedings, Davis suggested that the UK could pay for access to the single market while at the same time taking control back over UK immigration. Sterling was buoyed by the idea of a more collaborative Brexit stance. GPBEUR, which is now in the vicinity of post-Brexit highs, is on track for its fifth  consecutive week of gains, having rallied up to its highest level since early September. Sterling’s gains were not limited to the Euro; in fact the British Pound is up over 1% this week against the American and Australian Dollars, as well as the Japanese Yen.

This week’s activity could present an opportunity for sterling sellers. Since the October Flash Crash, sterling has rebounded strongly, up over 5% against most G10 currencies. This softens the blow of pre- and post-referendum losses. As of yet, there has been no comment from the EU side of the negotiating table about fee-based access to the single market. In the past, EU negotiators have been cool to the idea of “picking and choosing” which of the  four core freedoms (movement of capital, services, goods, and people) a member state may adopt. The position has quite clearly been all or none. Recent sterling gains could be in jeopardy if the EU maintains its hard-line position and talks steer back towards a Hard Brexit.

Looking to the week ahead, the first event to take note of is the Italian constitutional referendum over the weekend. The objective of the referendum is to assess the desire to reform the upper house of parliament. Supporters of the motion argue that this will streamline the bureaucratic process, thereby helping get much-needed banking and economic reforms written into law. Detractors are concerned that it would concentrate too much power in one place and perhaps also create a safe haven for corrupt officials. The reason that this matters to currency markets is that current Prime Minister Mario Renzi has suggested that he would consider resigning if the referendum were to be voted down. This in turn could trigger a general election and potentially hand more power to the anti-establishment Five Star Movement; which has advocated Italy leaving the EU. As such, a “No” vote this weekend could see euro open next week on softer footing.

Next Thursday the ECB will roll out a monetary policy update. ECB chief Mario Draghi has insisted, despite growing criticism, that his ultra-loose monetary policy is both necessary and working. He has argued that the cost of low-interest rates to savers is offset by the stimulus to business activity and spending. In fact, given recent comments from Draghi, there is growing speculation that the existing stimulus program might be expanded. Specifically, currency markets will be looking for an official extension to QE past the March 2017 soft end date, something Draghi has previously hinted at. More QE is likely to weigh on the common currency.

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