Can Brexit Progress Spur the Pound? Analysts Aren't Sure

By FeaturesDow Jones Newswires

Britain and the European Union moved closer to trade talks Friday, but many analysts still don't believe the pound and other U.K. assets will push past their Brexit slump.

The U.K. and EU reached an agreement on Brexit divorce terms after six months of tense talks, opening the way for negotiations to advance on a trade deal. Sterling, which has been at the epicenter of investor's reactions to Brexit, was roughly flat against the dollar at $1.347 and up 0.28% against the euro in late morning trade. The currency rallied by as much as 0.6% against the dollar Thursday, after media reports of a deal in the evening.

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The pound is now close to its highest levels against the dollar since the EU referendum in June 2016 and some analysts believe Friday's news gives the pound an opportunity to break out of its political cycle. However, others are skeptical of a new era, particularly as they question the details of Friday's deal.

"When you look at what has actually been agreed, I wouldn't even call it much of an agreement anyway," said Mike Riddell, fixed income portfolio manager at Allianz Global Investors. "They're parking an issue which is still live until the end of the trade talks."

The pound has mainly risen since April, as investors' deep pessimism over Brexit has lifted somewhat.

In one sign of that, speculators have held a small net long position on sterling in six of the last 10 weeks--meaning more bullish than bearish bets on the currency's value--according to the U.S. Commodity Futures Trading Commission. Before then, speculators held a net short position against sterling for 98 consecutive weeks.

"The key change next year is that the market's sensitivity to Brexit negotiations should fall substantially," said Jordan Rochester, a currency strategist at Normura, who suggested the pound should gain to around $1.40 as 2018 begins.

Sterling could rise to $1.36 in the near term, according to ING foreign exchange strategist, Viraj Patel. But he thinks sterling won't rise much further than that, as "the hard part is still to come."

Negotiators must "get to the nuts and bolts of the economics of Brexit," he said.

How much investment can return to the U.K., as well as how much access to European markets a new trade deal between London and Brussels can retain, is important for the pound.

Investors and analysts spent Friday morning sifting through the terms of the deal. Many were unconvinced by it.

Allianz Global's Mr. Riddell said that based on the text of the announcement, he would remain bearish on the pound and U.K. government bonds even if the market reacted positively to political developments.

"If there was a breakout, if sterling rallied loads or if gilt yields rose considerably in reaction, I would take the other side of that," he said.

On Friday, British 10-year government bond yields ticked up to around 1.32%, from 1.25% when markets closed Thursday. Gilt yields have been generally lower since the referendum, falling to as low as 0.5% in August 2016.

Friday's statement promised to maintain "full alignment" with the rules of the EU's single market and customs union if no alternative agreement was reached. How such a pact fits with the British government's policy of leaving the single market is unclear.

"What we heard this morning doesn't fully answer the question of the Irish border," said Jane Foley, senior currency strategist at Rabobank. How London and Dublin handle the border between the Republic of Ireland and Northern Ireland has been a sticking point in talks.

"The economic integrity of the U.K. is still in question," said Ms. Foley.

Some analysts warned of potential economic knock-on effects if a rise in the pound was sustained.

"If sterling were to hold on to its recent appreciation, then the squeeze on real wages, which depressed consumption in 2017, may ease significantly," said Karen Ward, chief European market strategist at J.P. Morgan Asset Management. Until recently, Ms. Ward was an adviser to Philip Hammond, the British Treasury chief.

Write to Mike Bird at Mike.Bird@wsj.com and Olga Cotaga at Olga.Cotaga@wsj.com

(END) Dow Jones Newswires

December 08, 2017 07:37 ET (12:37 GMT)