Sterling looks poised to stay at its post-Brexit vote lows as its general election rally is cut short following reports that Boris Johnson is pushing for a hard deadline for the UK’s transition out of the EU by the end of next year.
The pound was trading 1% lower against the dollar and the euro on Tuesday morning at $1.32 and €1.18 respectively, as markets reacted to news that the prime minister is trying to write into law that the transition or implementation period must end by December 2020, effectively cutting short the time it has to negotiate a trade deal.
This was a sharp reversal from its high of $1.35 the day after the general election when domestically focused UK stocks in the FTSE 250 surged on the back of Johnson’s landslide victory.
The election result prompted a euphoric response from UK managers, particularly those that invest in out of favour areas of the market like the banks and housebuilders.
Merian UK Alpha manager Richard Buxton said the “sheer scale” of Johnson’s majority made the threat of a “cliff-edge” Brexit scenario less likely and predicted sterling could hit $1.40 sooner than expected.
New “cliff edge” emerges
Legal & General Investment Management multi-asset fund manager Willem Klijnstra described the yo-yoing pound as a “typical ‘buy the rumour, sell the fact’ move”.
“Markets like certainty, and a Conservative majority does give more clarity, explaining the initial strength, but it didn’t take long for us to be reminded that on Brexit we’re just reaching the first milestone,” Klijnstra said.
“Boris Johnson’s attempt to make the end of 2020 a hard deadline for the transition, brings back the potential for a cliff edge.”
Hermes Investment Management senior economist Silvia Dall’Angelo (pictured) agrees Johnson’s hard deadline for the transition period at the end of 2020 means “a new cliff-edge is now emerging for the end of next year if there is no trade deal in place by that time”.
“Twelve months is a very short time to negotiate a new trade agreement and the spectre of WTO trading arrangements kicking in at the of 2020 is now looming,” she said.
Sterling to stay pinned at post-EU Referendum levels
Dall’Angelo said she wasn’t surprised by sterling’s backward slide, having told Portfolio Adviser in the days before the general election that the pound hitting $1.35 on a Conservatives majority would be a “knee-jerk” reaction.
“Our long-held view has been that the pound would remain in the range that has prevailed since the EU referendum over the next year or so (ie cable between 1.20 and 1.40) because of persistent Brexit-related uncertainty and that the post-election relief rally would fade once a new sequence of deadlines concerning the negotiations of a trade deal with the EU would emerge,” said Dall’Angelo.
Dean Turner, economist at UBS Wealth Management, expects sterling to trade between $1.30 and $1.40 until June before the deadline for extending the UK’s transition period beyond the end of 2020 on 1 July.
But he added: “The risk of the UK reverting to trading with the EU on WTO terms could still drive larger GBP moves, particularly given the latest noises coming out of Downing Street.”
Klijnstra said the LGIM multi-asset team remains neutral on sterling for the time being. “But we do see value in UK equities versus the rest of the world,” he added.
