Constructive Brexit talks between UK politicians have imparted a sense of renewed optimism that has lifted the British pound to a 2-week high against the dollar and to a 3-week high against the euro.
A “really constructive” discussion between the Conservative and Labour parties suggests that Prime Minister Theresa May is warming to the investor-friendly idea of a permanent customs union with the EU and as such has lifted the British pound to multi-week highs against both the dollar and euro, at $1.31 and €1.165.
May’s concession on a customs union would be extremely unpopular with members of her own party but some reports on Wednesday suggested that senior government officials were hopeful that a cross-party agreement on a way forward — one that would include a customs union of sorts — might come as early as next week.
The UK’s withdrawal from the EU was originally scheduled for March-29 but with gridlock in Parliament, at the eleventh hour the Kingdom was granted a Brexit extension until the end of October.
Foreign exchange rates are reflecting a perceived reduction in downside risks to Britain’s currency — Wednesday marked sterling’s fourth consecutive day of gains against the dollar — though some risk clearly remains, which makes March’s high of $1.338 the likely ceiling to currency appreciation in the short term.
While the threat of “no deal” has been eliminated for some, a very real risk that might send the pound to levels as low as $1.24 according to one UBS strategist is a general election — something that the Labour party has said it will pursue if it cannot force changes to Theresa May’s Brexit deal. With Labour consistently ahead in the polls, the heightened levels of uncertainty that would precede an election would undoubtedly force many investors to abandon their sterling positions in favour of safer currencies.
Should the UK go on to find a cross-party consensus and then strike a deal with the EU, most analysts believe that sterling will be 7 to 11 percent higher at levels between $1.40 and $1.45. In the week leading up to the UK’s referendum on EU membership in June 2016, sterling averaged $1.462.
Unlike some other major central banks such as the Reserve Bank of Australia (RBA), the Bank of England is not expected to adopt an explicit (or even suggestive) dovish bias when it delivers its closely-watched Inflation Report on Thursday since that could exert unwanted pressure on the pound. Also on Thursday, the BoE will announce its latest decision on interest rates, which are universally expected to be left unchanged at 0.75 percent.