Brexit Reality Check Hits Sterling

UK facing Financial Services Isolation

The pound fell against the Euro as the reality of Brexit and the U.K.’s probable isolation from the Financial Services Passport were brought into sharp relief. EU Chief Negotiator Michel Barnier commented that there was no provision for a country outside the single market to have access to the agreement whereby banks can sell financial services products across the entire region. Barnier was quoted as saying that “there is not a single trade agreement which encompasses financial services”.

This stance will come as a blow the U.K. which was preparing its own proposal to allow EU bank branches to continue to operate in the U.K. without having to change their status to that of subsidiaries.

The pound fell versus the single currency reaching 1.1279. That area is now significant support for the pound since it is the high of 28th November that when broken allowed the pound to reach its recent high of 1.1507. The 1.1280 level has now held a few times in the past couple of weeks although were it to break it would signal a fall to the 1.1080 area which has provided support throughout Q4. Versus the dollar the pound rallied to reach 1.3405, a level that has also capped Sterling overnight.

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Narrow ranges to prevail until year end

It is the nature of the financial market that as soon as a prediction is made it needs to be reviewed. However, experience dictates that, as this week ends, traders will “draw the shutters” over 2017.

This has been a year characterized by strange choices that have baffled markets and driven volatility. Donald Trump’s withdrawal from the Paris accord on climate change, Theresa May’s June General Election and The U.K.’s “dovish hike” have been just a few of the decisions that in retrospect may have been foolish. Donald Trump will continue to believe that he is right, and the rest of the world is wrong regarding global warming, but Theresa May and Mark Carney must shudder at those decisions given the short-term outcome and the fact they will have long term significance.

There is little time in the modern world for reflection, but it must be hoped that the U.K. makes better decisions over its negotiating stance over Brexit stage two that it did over the preliminary agreements. A higher level of preparedness plus a more, if not belligerent, then certainly assured stance is needed to ensure that the EU doesn’t make demands that weakens the U.K. in global terms going forward.

2018 to bring more of the same

The dollar will continue to be driven by monetary policy in 2018 but that will be made more interesting by the arrival of the new Chairman of the Federal Reserve, Jerome Powell who will take office on 3rd February.

Powell is a lawyer not an economist or banker and will bring a more forensic attitude given that he is used to being reactive to facts rather than proactive to forecasts. The source and direction of inflationary pressure will need to be real before a further hike will be sanctioned. Markets still discount three hikes in the next twelve months a view that is perhaps a little more hawkish than the current data warrants.

The Euro will be pulled in one direction by the continued improvement in the Eurozone economy but will be pushed in the other by the politics of the region. The Austrian and German coalitions and Italian elections will provide a backdrop of uncertainty. Monetary policy will not be changed while there is a possibility that even a single nation lags the rest in its level growth according to ECB President Mario Draghi.

As opinion polls in Italy begin to predict the outcome of the May election, there may be pressure on the single currency should the rise in nationalism and anti-Brussels feeling feed through into a right-wing victory.