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Abu Dhabi, UAEWednesday 24 October 2018

Pound set to be tested as Brexit D-Day looms

But analyst says downtrend in euro-sterling expected to now slowly fade out

UK Prime Minister Theresa May might not get all her EU demands met. Getty
UK Prime Minister Theresa May might not get all her EU demands met. Getty

The pound benefited in recent days from optimism that Britain and the European Union are getting closer to a Brexit deal but this week could test that view.

An EU summit kicks off on October 17 and the UK must submit a proposal on the contentious Irish border issue by Wednesday to allow envoys of the bloc to begin preparations ahead of the meeting. Any confirmation that the two sides will be able to work out their differences would push the pound higher and fuel a further slide in gilts, say strategists and fund managers.

The EU is set to offer the UK a free-trade deal deeper than any agreement that’s gone before, but will reject Prime Minister Theresa May’s demand for “frictionless trade”, according to EU diplomats. The bloc’s vision for future ties with Britain will contain “about 30 to 40 per cent” of Mrs May’s pitch for a wide-ranging trade and security deal, two of the diplomats said.

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“The mood music is clearly more positive but this is the first of three possible summits where we can agree the withdrawal agreement and the outline of the future relationship,” said Investec Asset Management portfolio manager Russell Silberston. “I’m not sure anything else matters for the pound.”

Sterling gained and gilts slid toward the end of last week after Mrs May’s success in navigating her own party’s annual conference boosted optimism in the government’s ability to clinch a deal with the EU. Still, Mrs May’s political allies the Democratic Unionist Party could still put a spanner in the works, according to Commerzbank strategist Thu Lan Nguyen.

“The pound’s recovery potential will remain limited until we clearly get one of the parties to back down on its ‘red lines’,” she said. “Therefore, I would expect the downtrend in euro-sterling to now slowly fade out, or at least, it will be driven further by euro weakness, not by pound strength.”

As for UK government bonds, yields will likely be driven higher as part of the broad sell-off unfolding across global debt markets while investors will be watching the results of a syndication due early in the week.

The market will also be looking out for the August trade balance data and industrial production figures due on Wednesday.