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GBP: Brexit breakthrough - ING

According to Viraj Patel, Foreign Exchange Strategist at ING, it looks like GBP is breathing a sigh of relief as Season 1 of ‘Solving Brexit’ comes to an end, but be sure to tune in to Season 2 early next year as the narrative turns to transition deal and trade talks.

Key Quotes

“Following today’s Brexit divorce deal resolution, our attached report GBP: Less noise, more poise provides more detail on our thinking for the pound’s outlook in 2018. Below are some key highlights.”

“Season 1 of ‘Solving Brexit’ ends on a high…

  • In what is quickly turning into a reality TV show, the latest episode of ‘Solving Brexit’ has ended on a high for GBP, as a last-minute deal between Theresa May and the DUP on the Irish Border has enabled initial Brexit divorce proceedings to be wrapped up. In a joint statement with PM May in Brussels, the EU’s Jean-Claude Juncker said that ‘sufficient progress’ has now been made – such that Brexit talks can move onto discussions over a future trade deal.
  • While the divorce details will still need to be ratified by respective domestic politicians (EU leaders and the UK government), it looks as though this is now just a formality. While agreeing a ‘divorce bill’ has little economic significance for the price of GBP, the political significance of progress in Brexit talks is quite profound – not least as it reduces the tail risk of a 'no deal' scenario and a complete breakdown in negotiations.
  • Our game theory application to Brexit negotiations is proving a handy framework for analysing the political risks to GBP. While much of 2017 has been marred by UK and EU politicians playing ‘hardball’ with one another, the resolution of a Brexit divorce deal suggests the tide may be turning in a constructive direction. Politicians moving away from seeking to protect their own domestic interest (the Prisoner's Dilemma scenario) – and slowly moving towards a mutual agreement – is unambiguously positive for GBP.
  • GBP is broadly higher on the news, although we may see some profit-taking as a reassessment of the Brexit political games looks to already be priced in. While the hard part (trade talks) is still to come – and a realisation of this may keep GBP/USD capped at 1.3550/1.3600 in the near-term (EUR/GBP around 0.8650/0.8700) – we do ultimately believe that there is more upside left in GBP over the next 3 months.”

“Brexit transition deal is a weak GBP’s antidote

  • We believe that GBP markets are underestimating the cyclical economic benefits of a Brexit transition deal. Judging by GBP's rally since early November, a reassessment of the Brexit political games looks to already be underway.
  • But we feel there is more upside to come – especially if a transition deal were to be signed, sealed and delivered in 1Q18. Our ‘GBP Brexit Equation’ (below) demonstrates the chain of logic here. With a range of indicators suggesting that the UK economy is at a standstill, a reduction in medium-term uncertainty may rekindle some of the ‘animal spirits’ among consumers and firms – and see more cash put back to work over the coming year.
  • At a time when the BoE is in tightening mode, positive revisions to the UK growth outlook – and a subsequently steeper rate curve – could be a powerful pick-me-up for a weak pound.”

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