Image © Pound Sterling Live.
– Wednesday snapshot: GBP/EUR @ 1.1164 | GPB/USD @ 1.2442
– Barnier says ready to rework parts of Brexit deal
– Pound appears to have eaten its full share of ‘no deal’ fears for now
Boris Johnson has confirmed as the new leader of the Conservative Party, and will inherit the position of Prime Minister today as a result.
Prime Minister Theresa May will take part in her final Prime Minister’s Questions, before going to Buckingham Palace to tender her resignation. Johnson will then ask the Queen for permission to form a Government and then assume power.
The confirmation that Johnson has won the leadership coincides with a tick higher in the value of Pound Sterling.
“The Pound was volatile yesterday following Boris Johnson’s victory speech, as well as remarks from the BoE’s Haldane and Saunders who indicated they are not likely to vote for a rate rise in the near term. The Euro is under pressure ahead of tomorrow’s ECB policy announcement. The ECB is expected to prepare the ground for lower interest rates in September, although there is an outside chance of a reduction as early as tomorrow,” says Hann-Ju Ho an economist with Lloyds Bank.
The rally in Sterling following Johnson’s confirmation as the next leader appears to be a typical ‘sell the rumour, buy the fact’ reaction.
“Value buyers are coming in at these levels, sell the rumour buy the fact reaction,” says Viraj Patel, a foreign exchange strategist with Arkera, in reaction to Johnson’s win. “That 2:1 win for Boris isn’t as big as initially thought at the outset of this Tory leadership contest. May sit in the back of PM Johnson’s mind that he’ll have to be more appealing to Tory moderates than intended.”
While Johnson’s elevation is attracting much of the attention, we have a suspicion that Sterling’s positive price action might have more to do with the initial response from the European Union’s Chief Negotiator.
“We look forward to working constructively with PM Boris Johnson when he takes office, to facilitate the ratification of the Withdrawal Agreement and achieve an orderly Brexit. We are ready also to rework the agreed Declaration on a new partnership in line with European Council guidelines,” said Michel Barnier soon after Johnson’s win was announced.
Two points here: first, Barnier has again repeated the point that the existing Withdrawal Agreement won’t be opened, therefore the Irish backstop remains. Second, and perhaps of more significance to the markets, is Barnier’s offer to rework the political declaration.
This suggests the two sides will in fact be sitting down, and the door to a negotiated deal of sorts remains alive.
For now, we don’t see it likely that ‘no deal’ risks will grow substantially and this should therefore relieve some pressure off Sterling short-term.
The Pound-to-Euro exchange rate is currently quoted at 1.1149, having been as low as 1.1104 earlier in the day.
The Pound-to-Dollar exchange rate is quoted at 1.2465, having been as low as 1.2418 earlier in the day. Note GBP/USD is still struggling somewhat as the U.S. Dollar is easily the best-performing major currency of the day as investors cheer Republican and Democratic Party leaders after they struck a deal late Monday to fund the U.S. government for a further two years, which means there’ll be Autumn clash over the so-called debt ceiling this year and no repeat of the furlough that closed the government back in January.
Johnson is ‘in the Price’ of Sterling
Ahead of the announcement various tabloid publications were telling readers to immediately buy foreign currency as they warned the Pound would collapse on Johnson’s victory.
We said however that those with impending foreign exchange commitments would be wise to take a more sober approach on the matter.
That Johnson will become Prime Minister on Wednesday has more-or-less been known by markets for some time now, and is therefore ‘in the price’ of the British Pound: there will be no sudden crash in Sterling when Johnson assumes the highest office in the land as the canny investor would have done the selling weeks ago.
“I was asked repeatedly over the past week what events I was keeping an eye on in connection with Sterling. The result of the Tory leadership contest being announced today really will only indirectly be part of them. The result will be announced around lunchtime. A clear victory by Boris Johnson is likely to be fully priced in. That means only a complete surprise victory by his adversary Jeremy Hunt would move the market,” says Esther Reichelt, FX Analyst with Commerzbank.
Currency markets tend to react to the unexpected, and Johnson becoming Prime Minister is certainly not unexpected with boomakers offering odds with an implied probability in excess of 80% for such an outcome.
“Don’t bet on a big GBP reaction to new UK PM,” says Richard Pace, an options analyst with Thomson Reuters. “There’s unlikely to be much GBP reaction, judging by the price of options, overnight (Wednesday) expiry vol is 8.5 – a straddle break-even of 44 pips, that’s certainly not excessive and well below recent highs.”
Rather it is the first moves he makes in his new job, particularly on Brexit that will matter.
Notably, there is a chance Johnson could adopt a more pragmatic tone on Brexit than has been the case on the leadership trail. He would certainly be right to be more diplomatic considering he will be adopting a Government that is suffering a fast-diminishing parliamentary majority which is expected to be whittled down to just one within days as the Conservatives are expected to lose a key Welsh by-election before the week is done.
The by-election meanwhile comes days after the parliamentary party’s loss of Charlie Elphicke – the Conservative MP charged with sexual assault and subsequently suspended of the whip – and it becomes difficult to see how the new PM can govern for any length of time.
We hear reports on Tuesday that Johnson, wary of the fragile position he inherits, is already talking to Conservative MPs who might rebel against his government were he to pursue a Brexit they believed was to be too damaging.
According to a report in the Times, Johnson has held secret meetings with Philip Hammond, David Gauke and Rory Stewart “as part of a charm offensive amid concerns that they will prove to be a nightmare on the back benches”.
It is reported the incoming Prime Minister organised the meetings as part of a bid to unite the party amid opposition to his “do or die” approach to leaving the EU with or without a deal on October 31.
That Johnson is talking to this cabal suggests to us there is a chance he might be pursuaded to adopt a more pragmatic approach when it comes to delivering Brexit, and it becomes possible that a vote of no-confidence in the Government is ultimately avoided.
A significant tweet we picked up is that of Chancellor Philip Hammond who offered his congratulations to Johnson following his win:
“Congratulations Boris Johnson! You have said very clearly that you are determined to do a deal with Brussels – and you will have my wholehearted support in doing so. Good luck!”
It appears that there remains a sense that the Conservatives will get behind their new leader in his quest to secure a new Brexit deal. This should stave off any immediate threat of a General Election as there were fears that some pro-Remain MPs would resign from the party in order to vote with the opposition in any attempt to topple the government.
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From a strategic perspective there is therefore a danger in expecting a sudden drop in Sterling: the currency is heavily sold and any positive developments could be greated by a rapid, short-term relief rally. We are not suggesting a sizeable recovery; rather a bump within a negative trend.
In short, the currency market is awaiting triggers, and it could well be that the next major trigger to a move in Sterling is a positive one.
While our suspicion is that Sterling might be relatively stable over the next few days, there are of course risks.
“One of Johnson’s first tasks will be to appoint new cabinet members (all of course likely to be pro-leave). None of this is likely to be news for GBP, though there are still risks this week. Thursday is the last parliamentary session before the recess, which lasts to September 3. This would therefore be the final window for a confidence vote in the government (which it would likely survive, but GBP may still kneejerk lower) or for Johnson to voluntarily call an election (very small, but non-zero risk and also GBP-negative),” says Adam Cole, a currency strategist with RBC Capital Markets.
Note the probabilities of the negative outcomes: they are relatively minor.
If Sterling is to go lower we believe it would do so in a pattern that repeats the move lower we have seen since May which has been a relatively steady, if not determined, decline.
The trend remains lower, as we note in our week ahead forecast, but it also tends to be interjected with short-term recoveries.
“The daily chart, which we use to analyse the medium-term outlook including the next month, shows the pair in a nice and steady downtrend that looks set to continue. A break below the July 17 lows at 1.1048 would confirm a continuation down to 1.1000,” says Joaquin Monfort, our technical editor.
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