The pound rallied for a fourth day in a row on Thursday as investors rushed to bet on a Brexit trade deal, putting the currency on course for its best week since March.
Sterling surged above $1.36 by late afternoon in London to its highest level against the US dollar since May 2018 and up from just above $1.32 at the end of last week. The gains have been driven by signs that the impasse in UK-EU trade talks is thawing, with the EU’s chief negotiator Michel Barnier saying on Thursday talks were in their “final stretch”.
However, analysts said the pound’s almost 3 per cent rise this week — which is partly a side-effect of a broader decline in the dollar — is likely to leave little room for further gains once a deal is struck, while a last-minute failure in talks could trigger a sharp dive.
“I had been looking at $1.36 for a Brexit deal, and looking at my screen it’s already hovering around that level,” said Jane Foley, head of FX strategy at Rabobank. “We could see sterling pop above that on an announcement, but give it a week or two and I’d expect it to be back below. It could be a case of ‘buy the rumour, sell the fact’, and there will still be a lot of Brexit uncertainties out there.”
Against the euro, the pound’s gains have been more modest, but the currency is still up 1.7 per cent for the week — which if it holds would be its best performance since April — at €1.11.
Growing confidence that the UK will leave the Brexit transition period with an EU trade deal has also knocked government bonds this week. The 10-year gilt yield, which rises as prices fall, climbed to 0.29 per cent from as low as 0.15 per cent last Friday.
In early December, gilts had benefited from a series of setbacks in Brexit talks which spurred demand for safe assets and rekindled bets that the Bank of England would be forced to respond to a no-deal outcome by cutting rates or announcing further asset purchases to cushion the blow to the economy. Those bets have been unwound this week, and the BoE left monetary policy on hold at its meeting on Thursday.
As with currency markets, analysts now think the prospect of a deal is largely priced in by gilts. A surprise breakdown in talks could quickly push the 10-year yield down to zero as investors brace for a BoE response, said Pooja Kumra of TD Securities. “On the other hand, if we do get a deal, we expect the sell-off to be rather shortlived,” she said, adding that markets are likely to focus on the limited positive impact a “thin” trade deal would have on the UK’s economic prospects.
Even after its recent rebound, the pound remains well below the rate of about $1.45 to the dollar that prevailed in the run-up to the Brexit vote four years ago. Against the euro, it has barely recovered any of its 2016 plunge. Although investors now expect the UK to reach an agreement that avoids tariffs with its largest trading partner, the departure from the EU’s single market is likely to erect other barriers to trade.
“Any deal that’s on the table now is what we thought of as a very hard Brexit two or three years ago,” said Mike Riddell, a portfolio manager at Allianz Global Investors. “Are we going to see UK growth suddenly rising from the flames? I don’t think so.”