Will the pound suffer despite Brexit breakthrough?

Despite the UK and EU agreeing to move into the trade negotiation phase of Brexit, there is reason to believe that the pound could suffer in 2018.

Source: Bloomberg

With the UK and EU making ‘sufficient progress’ to enable the next stage of Brexit negotiations, the UK appears to be moving in the right direction, despite fears over what Brexit might look like. However, it has been notable to see that the pound’s initial strength turned to weakness, with GBP/USD falling sharply in the hours after the announcement. Much of this has got to do with the manner of the agreement, and the expectations of future sterling drivers.

The agreement over the Irish border seems to be a fudge of the highest caliber, with the agreement alluding to keeping everyone happy without actually providing details of how they would do so. There is going to be a clear difficulty in achieving a completely open border, while at the same time enacting a Brexit for Northern Ireland that would mean an end to free movement of goods/people. The conditions specify that if the UK does not come up with such a satisfactory solution, then Northern Ireland would essentially have to remain within the single market and customs union. Given the fact that Monday’s suggestion led to calls from Scotland, London and Wales to have the same deal, the decision to give Northern Ireland a ‘Brexit Lite’ could be suicide for Brexit. Thus, while this hurdle seems to be overcome, it could still yet provide a major sticking point down the line.

Another reason to worry is that we are now moving into a process which is much more complex than a decision over how much money the UK owes to the EU. The ability to strike a deal that is right for all 28 parties is going to be incredibly difficult, and that has to be done on a sector by sector basis. There is little reason to believe that beyond today’s announcement we are going to see any positive news coming from the discussions anytime soon.

This brings us to the ‘buy the rumour, sell the fact’ market move we have seen today. The positive effects of the breakthrough have been short lived. And with an extended period of time until another positive announcement, there is a strong chance the markets will focus on the UK economy, which is likely to continue to slow. The positive surprise in manufacturing and construction purchasing managers indexes (PMIs) were overshadowed by yet another weak services figure, which is likely to drag growth. This negative effect is likely to be heightened by the deteriorating consumer and business confidence.

With all of this in mind, there is a strong chance that we could move into a more bearish period for the pound. However, looking at the long-term picture, we have not yet broken from the uptrend that has dominated throughout 2017. The bearish breakout from the 2017 channel would come with a break below $1.3039. Interestingly, we are seeing some tentative signs of weakness with a bearish divergence in play, with higher highs and higher lows in price being confounded by lower lows and lower high on the stochastic oscillator. The next major hurdle to overcome for the pound is at $1.3659, where a break above it would provide another higher high. However, despite today’s new, there are reasons to believe that we could see the pound weaken as we move through 2018.

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