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The pound has started the week in explosive fashion today, with the growing risk of a Tory vote of no confidence pushing Theresa May towards the brink. This adds into a Brexit story which appears to be leading the UK towards a messy exit from the EU, with a host of unpredictable and dangerous consequences for the economy.
Unfortunately, the lack of confidence in Theresa May is likely to be symptomatic of the situation the country finds itself in as much as anything. With such an array of opinions over what Brexit should look like, there will continue to be MPs who believe it serves their interests to undermine any candidate that fails to fully represent those views.
With that in mind, political instability is unlikely to go away, irrespective of who is leading the UK, and for as long as negotiations continue we will see the EU give away nothing, while the Brexiteers push for unrealistic outcomes. The EU is quite happy to see increased brinksmanship, touting any failure to agree as the UK’s stubbornness rather than their own flexibility. Meanwhile, companies move operations to the mainland, benefitting the EU, and UK economic data stalls as UK workers fear for the economic future, further helping the EU narrative that the UK was foolish to even go on this path.
The EU is likely to see this as an opportunity to punish the UK to an extent, in an attempt to ensure that no one will ever leave in the future, and perhaps even force another referendum. Ultimately, get used to the fact that negotiations are going nowhere near fast, because the UK doesn’t even have a common position that is achievable, and the EU has very little interest in this process going ahead smoothly.
For the markets, this is likely to have a clear effect, with increased economic decline providing downside for the pound, while the FTSE 100 gains ground given the inverse correlation with sterling. Of course, we could see Theresa May roll over and agree to a huge divorce payment to push us into the trade negotiations phase. That would likely provide a significant bounce for the pound, yet with just 16 months until we leave the EU, the focus will have to be on a transitional deal rather than a full trade deal. There are plenty of elements within such a deal that could see the UK economy hit hard if not achieved. As such, that bounce could be short lived once likely outcomes of the deal become clear. The recent savour for the pound has been the Bank of England (BoE), with Mark Carney and co raising rates owing to rising inflation. With that in mind, inflation will be a crucial indicator to watch. However, it is highly unlikely we will see many more rate hikes to come, and as such the bearish theme is likely to return soon enough if a divorce settlement isn’t agreed swiftly.
With that in mind, there is a strong possibility that the pound will begin to reverse the uptrend that has been in place through 2017 so far. The weekly timeframe highlights the bearish divergence between the price and the stochastic oscillator, pointing towards a trend of falling momentum despite continued highs. The level of support that needs to be broken for a bearish picture to be confirmed comes in the form of the August low of $1.2774.