COVID-19 has been a dominating force in FX this year and will continue to be so in the foreseeable future. However, there is an event risk that is just appearing for one, final, time before being put to bed once and for all, and that is Brexit.
Now before we go on, Brexit is very singularly focused from an FX point of view in that it is completely a GBP issue and realistically it’s almost just an EUR/GBP issue. Which from a trading point of view is a good thing, as the cause/effect relationship is easier to find and trade. Again, the caveat is COVID-19 - if there is more positive news about caseloads over the coming week in the UK and Europe, that will help EUR/GBP.
The reason that Brexit remains a short-term volatility risk is that the final agreed-upon free trade agreement (FTA) between the UK and the EU is going down to the wire, and there are very specific, very costly trade issues causing this.
Here are the main sticking points:
• The EU is worried the UK will give financial help to its own firms, which it says would give them an unfair advantage.
• The UK is concerned about who will be allowed to fish in its waters – the Netherlands, Belgium and France are very concerned that the English Channel and water in the North Sea will become ‘bordered’ and fishing will be impinged.
• The EU fears the UK is trying to change an agreement made about the complicated case of the Northern Ireland border known as the Backstop - the only part of the UK to have a land border with the EU. Could this be used as a backdoor for trade and movement of people against EU policy and interest? That is the question.
Now looking at EUR/GBP over the past week as the politics has increased the pair has risen on those tensions. Seen here:
However, the chart shows that the moving averages and the trend is to the downside over the medium term. And that is because the base case is that a FTA will be reached. This is a positive for the UK and thus a positive for the GBP. Remember the pair has fallen over 19% in the past five years, the GBP has some room to recover. Thus, if we see further steps been taken to finalise a deal, we expect the pair to fall as the Brexit hurdle is finally cleared.
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