The pound dropped on Thursday after the latest round of high-level trade talks between the UK and the EU failed to provide a breakthrough, extending a volatile run for the currency.
A UK government official said that “very large gaps remain between the two sides” despite Wednesday’s meeting between Boris Johnson and European Commission president Ursula von der Leyen. The two sides set a final Sunday deadline for a “firm decision” on any potential deal.
Sterling slipped 0.7 per cent against the dollar to $1.3302 by late afternoon in London and fell 1.1 per cent against the euro. But the level of the currency — which on Wednesday climbed near to its high for the year against the buck — still implied a widespread assumption a deal would be struck, analysts said.
“I think people always expected this would go down to the wire,” said Seema Shah, chief strategist at Principal Global Investors. “But the fact that the two sides seem quite far apart at this late stage is worrying for markets.”
The pound has been buffeted by political developments over the past few days as traders try to work out whether last-ditch negotiations will yield a trade agreement before the Brexit transition expires at the end of December. That has sent implied one-month volatility for the currency to a level not seen since the aftermath of the coronavirus sell-off.
On Thursday, Brussels set out its contingency plans to prevent immediate disruption to a number of sectors in the event that a deal cannot be reached.
Chris Ralph, chief global strategist at wealth manager St James’s Place, said there was significant “downside for sterling” but added that for the pound to slide back to its March lows of around $1.15 there would “have to be a big falling out” and a chaotic end to Brexit talks.
The yield on 10-year UK gilts was flat at 0.2 per cent by late afternoon trading, having rallied earlier on as investors sought haven assets. They remained on track for their biggest weekly price gain in six months.
Gilts have been boosted in recent days by renewed wagers on the possibility of interest rate cuts from the Bank of England. A week ago, investors had unwound bets on the possibility of sub-zero rates as the arrival of Covid vaccinations fuelled optimism about the economic recovery. But those wagers have begun to resurface as the impasse in the trade talks reignites concern over the path of the economy next year.
Two-year gilt yields, which are highly sensitive to expectations for short-term interest rates, slipped to their lowest in more than two months at minus 0.12 per cent.
“Even if there’s some kind of compromise reached there will be considerable difficulties,” said Peter Schaffrik, macro strategist at RBC Capital Markets. “But if there’s no deal and the economy receives another body blow the market reaction will be to price in further rate cuts.”