UK: Predictable pound selling yesterday might not last - MUFG

According to the Derek Halpenny, European Head of GMR at MUFG, there was a certain lack of logic to the selling of the pound given there has been nothing dramatically new provided in terms of the weekend press speculation that the UK would seek a deal with the EU on the basis of accepting the UK’s exit from the Single Market.

Key Quotes

“In or out of the Single Market really isn’t the issue anymore and what is far more important is what agreement is reached on how that is achieved. In other words, what measures will be taken to avoid any sudden dramatic change to the trading relationship between the UK and the EU?”

“So it is the transitional nature of the deal perhaps that may prove important going forward. We are unlikely to get much colour on that today, mainly given that will only become apparent once negotiations begin. But we believe market participants are perhaps under-estimating the potential for PM May to focus more today on stressing the focus of the UK will be ensuring a deal that limits the potential negative macroeconomic impact for both the UK and the EU. Post-Brexit, the UK will be as large an EU export destination as the US and hence such a deal will be in the interest of both sides during the Brexit negotiating process.”

“Expectations management will play an important role in market reactions to Brexit developments and what looks like an orchestrated leak of ‘bad’ Brexit news leaves much greater potential for the markets to respond more positively to the speech itself (11:45am GMT). Some surmise that simply assuming a repeat performance for the pound that followed PM May’s speech last October which signalled ‘hard Brexit’ is justification for shorting the pound again now. We doubt trading the pound will be that simple and today may highlight the fact that pound direction will be far more complicated than simply second-guessing Brexit events as being perceived by the markets as ‘hard’ or ‘soft’.”

“One additional variable to be incorporated into the outlook for the pound is of course the relationship with the US as UK-EU negotiations get underway later this year. President-elect Trump stated over the weekend that he thought “Brexit would be a great thing”, promising a close working relationship going forward. Throwing Trump into the Brexit negotiations equation certainly raises the potential for a better deal in the end – something the markets are giving little attention to at this stage.”

“Finally, our more bullish view on the pound for this year is partly based on our assumption that the monetary bias of the BoE may change later in the year given the fact that the UK economy continues to show resilience. Perhaps the biggest greatest surprise post-Brexit has been the strength of the UK economy and at some stage market participants are likely to begin questioning the need for the easing measures taken by the BoE last August. In a speech yesterday evening Governor Carney stated that there were “limits to the extent to which above-target inflation can be tolerated”.”

“A continued better than expected performance of the economy would therefore become a greater support for the pound as BoE monetary policy expectations begin to change. Signalling a limit to inflation tolerance will help provide a floor for the pound over the coming months. One key reason behind our view of a weaker US dollar later this year is that central banks outside of the US will begin to signal intent to follow the Fed in 2018. We include the BoE in that scenario and Carney’s speech reinforces our view on that.”