EUR/GBP: risk of no-deal Brexit looms large again

15 June 2020

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There are the risks we know about – the inevitable bankruptcies, rising unemployment, a new wave of the virus taking shape in several American states, such as Texas and Florida – and then there are the risks we know less about, which could generate substantial volatility on the foreign exchange market. Foremost among the latter is Brexit. While the United Kingdom’s exit from the European Union had attracted the attention of market operators throughout 2019, it has since been completely overshadowed by Covid-19. However, we have now entered a period of great strategic importance for the United Kingdom and the EUR/GBP currency pair.

London has until the end of the month to request an extension to the transition period, which has been ruled out for the moment. To put it mildly, the ongoing negotiations with Brussels are not moving in the right direction. Market sentiment towards sterling has significantly deteriorated over recent months. The EUR/GBP pair is up 6% since the start of the year, with gains of 1.3% in the past month. The cross remains close to 0.90, but we cannot rule out a return to somewhere in the region of 0.93-0.94, its highest value so far this year, if negotiations go wrong.

At this stage, several scenarios are being mooted from the British side:

  1. The majority position within the UK government is not to request an extension, but rather to start dealing with post-Brexit arrangements now, during the coronavirus pandemic, in the hope that the subject will not have adverse consequences on the economic recovery when it comes.
  2. Another scenario, which seems to have minority support and was proposed by a former adviser to the last Prime Minister Theresa May, would be to extend the transition period by six months and use the additional time solely to implement any new measures agreed between now and October 2020. If no deal were reached with the EU by that date, negotiations would stop. However, this could at least give companies a little more time to prepare for the changes that lie ahead.

On the EU side, it is clear that the negotiators are exhausted and eager to get Brexit done and dusted as quickly as possible so as to focus their attention on subjects considered more urgent, such as the recovery plan proposed by the European Commission. We therefore cannot exclude the possibility that the EU will, contrary to its previous stances, reject the idea of an extended transition period, even if that means a no-deal Brexit. European decision-makers and the foreign exchange markets have understood that the United Kingdom and the pound have more to lose than the EU and the euro.

Whatever happens between now and the end of June, sterling looks set for a tumultuous next few months. A host of factors are combining to drive down its value against the euro. These include uncertainty about Brexit, the significant economic slowdown that lies ahead and the very poor management of the health crisis by the UK government. Among the major European economies, the United Kingdom is the only country where the pandemic is continuing to spread. With more than 290,147 cases identified to date, the country is the fourth worst affected in the world, after the United States, Brazil and Russia. What is more, the pandemic is going to result in a sharp economic slowdown. According to OECD forecasts published last week, the United Kingdom is likely to suffer the worst recession among developed economies this year, with GDP expected to fall by 11.5%. And those forecasts make the optimistic assumption that a deal will be struck with the EU... If a second wave of the virus were to hit, the economy could contract by 14% this year. Gradually, steps are being taken to avoid a sustained depreciation of sterling against its main rivals, notably the euro, in the months ahead.

Economic calendar

DATE CURRENCY EVENT
16 July EUR

ZEW Economic Sentiment Index for Germany (June)

16 July USD

US retail sales for May

18 July GBP

Meeting of the Bank of England

18 July USD

Philadelphia Fed Manufacturing Index

19 July EUR

European Council videoconference

 

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