Risk of “no deal” weighs on the pound

The pound has fallen by almost 10% against the US dollar over the past four months, leaving it at $1.29. Much of this reflects broad-based dollar strength – the pound has slipped by much less against the euro. But the growing possibility of the Brexit negotiations ending in “no deal” is weighing on the currency, and is reflected in an increase in short positioning in sterling and greater demand for put options as insurance against a further fall. Given the apparent lack of progress in the negotiations, there seems little prospect of the pound rebounding before the end of the year. Indeed, we now think that a deal will only be reached at the eleventh hour, in early 2019. However, provided a deal is eventually struck, the Monetary Policy Committee is likely to press ahead with further policy tightening. As a result, while we think the pound could slide a little further, to $1.25 and €1.09 by year-end, a reversal is likely in 2019. We have pencilled in a rebound to $1.45 and €1.21 by the end of next year.