Sunday, March 03, 2019
This sterling rally was built on shaky foundations
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on This is an excerpt.

For those of you who like a fact to kick off the day, how did sterling, as in pound sterling, get its name? The answer, which is shrouded in the mysteries of Middle English, is that it could have come from starling, as in bird, which featured on early coinage, or “sterre”, Middle English for star, which was on some Norman coins in circulation in Britain.

I mention this because sterling has been in the news. Though it slipped a little towards the weekend, It has had a good week. Currency dealers have been watching the parliamentary shenanigans very closely, and decided that they merit marking the pound higher. As in the period since the June 2016 referendum, sterling has been acting as Brexit barometer.

While it would be an exaggeration to say that currency markets now think that it is all over, and that a no-deal Brexit has been definitely avoided and an extension of the Article 50 process beyond March 29 is a near certainty, the fact that things have been moving in that direction propelled sterling to the giddy heights of $1.33 and €1.17.

Simon Derrick, the veteran currency strategist at BNY Mellon in London, said the pound’s rise was overwhelmingly explained by the prospect of a delay of some weeks to Brexit, and that markets had not yet thought through the implications of other developments, such as the Labour party’s apparent shift to supporting a second referendum. He also noted that at $1.33, sterling was not much above its post-referendum average of $1.3050.

This, by the way, compares with a $1.58 average for sterling against the dollar for the three years before 2016. Currency markets effectively downgraded the economy, and the pound, after the Brexit vote.

In the low $1.30s, then, the pound is still in what dealers would see as a neutral range. But it is above its post-referendum closing lows of just over $1.20 and €1.08. What might push it higher still?

Adam Cole, currency strategist at RBC (Royal Bank of Canada) Capital Markets, has in response to client requests updated his subjective Brexit probabilities. They are now 5% for a no-deal Brexit, down from 15%; 35% on exiting on March 29 with a deal, 40% on exiting later, also with a deal, and 20% on Brexit not happening at all, possibly as a result of a second referendum. A second vote, he suggests, would be 60% likely to overturn the result of the 2016 referendum.

Of these various outcomes, he argues, there would be scope for a small 2%-3% rise in the pound on exit with a deal now, or after a short delay. The most sterling-friendly outcome, as its performance since the referendum implies, would be for Brexit not to happen.

These exercises are useful . They show why last week’s tilt away from a no-deal Brexit and towards a Brexit delay have been positive for sterling.

Sterling’s performance is also, however, on the face of it a little odd. The prospect of a delay to Brexit came because a weakened prime minister had to give ground to parliament, including members of her own cabinet. The political crisis, which is afflicting both main parties, has deepened rather than gone away.

In response to the prospect of delay, one of her junior ministers, the Eurosceptic George Eustice, himself resigned on Thursday, the 12th minister to resign over Brexit in less than nine months. This is still a chaotic government blundering from one Brexit crisis to the next, not normally a recipe for a strong currency. Sterling had the good grace to soften a little on news of that resignation.

Nor, as was shown by Theresa May’s earlier strong resistance to extending article 50 beyond March 29, is it clear that a delay is anything other than a recipe for further muddle and confusion. As Emmanuel Macron, the French president, has said, delay has to be for a purpose, not merely so that the prime minister can keep banging her head against a parliamentary brick wall. Other EU member states have to agree a delay. They probably will, but on their terms.

Without March 29 as a hard stop, meanwhile, May has lost some of her domestic leverage. Hard Brexiteers can happily reject her withdrawal agreement, even if the attorney general Geoffrey Cox succeeds in extracting minor concessions, without that rejection resulting in an immediate no-deal. But that rejection would still leave Britain vulnerable to a no-deal Brexit a few weeks later.

That is why, while sterling has been enjoying the high life, there is not much joy elsewhere. As always, what is sauce for the sterling goose is not necessarily sauce for the domestic economy gander. It is now a given that when the pound goes up, the FTSE 100 goes down, because a high proportion of UK large quoted company shares are dollar-denominated.

It is also the case that developments that were greeted with enthusiasm in the currency markets were received rather less warmly by bodies representing British business.

“A short extension of article 50 simply moves the cliff edge back a few weeks and it doesn’t offer UK manufacturers confidence that we will not crash out of the EU a short time later than expected,” said Stephen Phipson, chief executive of Make UK, formerly the EEF, the manufacturers’ organisation. “This will be catastrophic to a sector that employs close to 3m people and accounts for almost half of our country’s exports.”

Carolyn Fairburn, director general of the CBI said the prospect of a delay to Brexit was merely “an option on sanity”, a small step away from the no-deal Brexit that would be “a wrecking ball on our economy”. Mark Carney provided a guarantee that if it were to happen, the Bank of England would be taking a wrecking ball to its growth forecasts.

For that reason, then, sterling’s recent strength may be no more a reliable guide to the future than February’s unseasonably warm weather was to the idea that we have relocated the country to the Caribbean. There is many a slip twixt cup and lip, and there will be many Brexit twists and turns in coming months for currency markets to digest.

UBS, the Swiss bank, put it well in a note from its chief investment office, warning people not to get carried away with sterling’s rally. All options remained on the table, it warned, including a continued political impasse and a no-deal Brexit. That still offered the possibility, it warned, of a further significant fall in the pound, to $1.15 against the dollar and to one-for-one parity with the euro. Not even those who see salvation in devaluation should want those circumstances to materialise.

We should, therefore, be a little cautious about sterling’s revival. It tells us something but, just as we talk about spot exchange rates, it is a spot judgment. These things change, and they could go either way. Some people like uncertainty, including some in the markets. They can expect plenty of that in the next few weeks.