December has been a ‘hot’ month for the pound with volatility directly linked to progress in the Brexit negotiations. Every time the headlines reported a positive development the British currency rallied only to retreat again when new obstacles came to light. The price action was capped within a narrow range between 1.33 and 1.3550, with the quick changes of direction making investors wonder whether this is a market to make profits, or one which is better to better stay away from.
The big breakthrough in negotiations came on Friday, December 8th when UK Prime Minister Theresa May and Jean-Claude Juncker, the President of the European Commission, announced that a deal had been struck. The two leaders reported that they had reached an agreement on the amount of the “divorce bill”, the rights of EU citizens living in the UK and the Irish border issue. However, contrary to analysts’ expectations the pound didn’t rally instead it reacted to the talk about the issues which will impact the next stage of the negotiations. EU officials were rather apprehensive when commenting on the breakthrough deal suggesting that a lot of time was wasted on the “easier” part of the talks. And it is true, the important issues which will decide whether Britons will have to live with a “hard” or a “soft” Brexit have to do with the trade agreements.
The pound’s outlook will be driven by the speed and success of these negotiations. For the UK, access to the Single market is essential because of the importance of the services’ sector in the domestic economy. If the deliberations so far offer any indication, it is unlikely that the EU will want to grant any kind of access which mirrors the current position. Therefore, getting any deal which satisfies her critics and supports the UK economy will be Theresa May’s greatest challenge.
Early in 2018 the pound is expected to again dominate the headlines as the two parties will start debating the access question and looking at how company’s passport their services to the EU and vice versa. There will also need to be agreement on the free flow of workforce and capital. As always, the price action will depend on the expectations shaped by these early talks: a fast pace with the two parties finding common ground will allow the UK currency to break to the upside but this is not our primary scenario.
Unfortunately for sterling traders, the most likely development is that the EU leaders will play hard ball and demand that the UK is treated like any other country who is not a member of the Union. This would be harmful for the pound and with the Bank of England poised to leave interest rates unchanged for the time being the UK currency may struggle for good news. Should our expectations prove to be true then a break below the 1.33 area could expose the 1.32 and 1.31 support areas.