Pound to Follow Politics as Scandal-Hit U.K. Renews EU Talks

Updated on
  • Currency dropped for third week despite BOE hiking rates
  • Economic data and Brexit progress move back to forefront

U.K.'s May Faces Heat on Brexit and Harassment

The pound is likely to be driven this week by the state of Brexit negotiations and U.K. politics, after losing support from bets on central bank policy tightening.

Sterling could see any slide exacerbated should it drop below $1.30, according to Morgan Stanley, with the resumption of Brexit talks, fallout from a sexual harassment scandal and industrial data to provide direction. The currency has fallen for three weeks on concerns about Brexit and as the Bank of England failed to signal the start of a tightening cycle after raising rates on Thursday.

The market has pushed back bets on a hawkish central bank, which had provided a floor for a currency depressed by mixed economic data and the lack of agreement with the European Union. The U.K. is now looking for a breakthrough on key sticking points before a EU summit in December, to try to move toward discussions on a future trading relationship.

“The BOE has removed a key support for the pound,” said Georgette Boele, a currency strategist at ABN Amro Bank NV in Amsterdam. “Brexit-related news will likely give sterling more direction in the coming weeks.”

BOE Governor Mark Carney said the next rate shift could depend on the outcome of Brexit. On Sunday, he told ITV’s “Peston on Sunday” program that the central bank may be unable to cut borrowing costs if the U.K.’s exit from the EU turns out to be worse than policy makers currently expect. 

Money markets currently price in another 25-basis-point rate increase in December 2018, compared with August before Thursday’s decision. That may coincide with any Brexit deal, with the EU’s chief negotiator Michel Barnier wanting it finalized by October next year.

While officials resume discussion in Brussels on Nov. 9, the U.K. government may be distracted by a sexual harassment scandal in Westminster, which has already brought down one senior cabinet minister and threatens to bring down a close ally and deputy of Prime Minister Theresa May. With her judgment being questioned and the government only possessing a small majority in Parliament, the issue is on traders’ radar as a tail risk for the pound, according to Nomura International Plc and Mizuho Bank Ltd.

Sterling rose 0.1 percent to $1.3083 as of 7:55 a.m. in London on Monday, after a drop of 0.5 percent last week, its third week of declines.

Unless the currency rebounds from a support line stemming from a low in April, a deeper correction may be coming as Bloomberg’s fear-greed indicator, which measures buying against selling strength, shows bears now control price action. Technical analysis suggests the latest move downward shows no sign of a reversal.

And with the process of leaving the EU casting uncertainty over the outlook, some economists have warned that the BOE rate increase may be a mistake. The latest readout on the economy will come from housing-price data on Tuesday and industrial production on Friday.

“We see further weakness in store for the pound over the medium term as economic data weaken,” wrote Morgan Stanley strategists led by Hans Redeker in a note to clients.

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