Theresa May survives the weekend, but Brexit issue still grows

Today's news headlines:

  • ‘Michel Barnier proposes extending Brexit transition to 2022’. Move would push exit date beyond next election. (Financial Times)
  • ‘After US-China clash at APEC, all eyes shift to the Trump-Xi meeting in Argentina’. Hopes build that the G20 meet will signal progress in trade talks. (CNBC)
  • ‘Italy stand-off raises concern of contagion’. Eurozone’s biggest issuer of sovereign debt presents growing risk to market. (Financial Times)

Unsurprisingly, Brexit remains at the top of the agenda for many currency market participants as the clock counts down to next weekend’s emergency EU leaders’ summit. This has been arranged to endorse the proposal document which was tabled last week—but would see the UK tied indefinitely into a customs union as a result. With a firm deadline in place, the political tempo in Westminster will accelerate markedly in the coming days, and a leadership challenge for Theresa May remains a very real possibility. The Prime Minister may have survived the weekend – and the Pound appears to have posted a token bounce in recognition of this fact – but it seems inevitable that hostility towards the proposals will increase in the near-term.

The weekend also saw the US and China meet as part of the Asia-Pacific Economic Cooperation (APEC) summit; although there was no progress seen here in terms of an outline trade deal between the two nations. This may well be seen at the G20 summit due to be held in Argentina later this month, especially if Donald Trump is looking for a potentially headline-making statement, but concerns are mounting over the short-term fallout which could be seen. A slowing Chinese economy is being bolstered by Yuan devaluation, but some Chinese companies who are using US Dollar denominated debt are being pushed towards the risk of default. Prospects such as this will do little to encourage risk-taking, and as a result, this could serve to push the Dollar higher across the board.

The Italian budget question is still on the table, with Rome refusing to budge against Brussels’ criticism of the austerity-busting proposals. Despite assurances from the Italian government that growth targets can be achieved and asset sales will be undertaken to reduce the deficit, the European Commission is tipped to trigger the so-called ‘Excessive Deficit Procedure’, possibly as soon as this week. That would leave the battle between the two ongoing into the spring, and through European Parliament elections which are expected to see fresh gains for anti-austerity parties. In other words, Italy has an incentive to ride this storm out, as six months down the line could see a far more supportive approach to such policies—although it’s unlikely to provide any medium-term support for the Euro.

Economic data is very thin on the ground today, although once again it’s the political narrative that stands to dominate. The Pound yet again has the potential to see some of the most significant swings as the battle over Brexit plays out further and as has already been experienced, movements on the currency could be both swift and significant in size.

GBP/USD

The Pound has made some gains from last week’s lows against the US Dollar, although there is plenty of safe-haven justification for buying into the USD for now. Unless some positive progress is seen over Brexit, the next move could readily be lower once again.

EUR/USD

The Euro made gains on Friday helped along by some better than expected inflation data, which in turn is providing support for the European Central Bank’s (ECB) plan to normalise monetary policy. However, sustaining this upside against a mounting risk-off bias and political uncertainty in the European Union could prove difficult.

GBP/EUR

Despite notable losses for the Pound against the Euro last week, the risk still remains weighted on the downside. This is attributed to the political uncertainty in the UK, and the fact that in the short-term, the UK arguably has more to lose from Brexit than the Eurozone. While a change in sentiment could see value hunters rushing in, against the current backdrop, this does seem unlikely.