Will Brexit roadblocks stifle GBP recovery?

With Theresa May starting to give concessions last week, it looks likely that Brexit negotiations will play an increasingly important role in GBP trading as time goes on.

IG Analyst

Publication date : 2017-09-26T16:14:39+0100

Source: Bloomberg

Last week’s appearance from Theresa May saw a potential ground breaker in Brexit negotiations, with a £20 billion package offered in exchange for the commencement of negotiations for a transitional deal. Unfortunately, this simply seems like yet another opportunity for the main actors on the EU side to push back on the UK negotiating team, as they signal to the remaining EU nations that it doesn’t pay to leave the group.

This desire to prove the UK wrong is likely to be a huge driving force in the negotiations, with one side of the table seeking to actively undermine discussions. Both sides of the negotiations have their audience, with EU nations pressing Barnier to stay steadfast, while a whole host of voices within the UK ensure that David Davis doesn’t give up too much ground. This provides us with a backdrop to these negotiations that are not conducive to a positive resolution. The longer these negotiations go without any breakthrough, the greater chance there is for businesses to take steps to mitigate a worst case scenario. That shift in business confidence is the type of thing that will inevitably impact the value of the pound via weakening economic data.

In a recent article, the relationship between UK data (services PMI) and the pound was highlighted. Those PMI readings will also be impacted by confidence of consumers to spend, and businesses to invest for the future. If the negotiations continue to point towards a roadblock, or an inability to obtain a deal in time, then the likeliness is that we will see the pound suffer. The image below highlights the relationship between consumer confidence and the UK services PMI.

Confidence v PMI chart

Given the general lack of knowledge throughout the country on the latest PMI data, it would make sense that we are seeing consumer confidence impacting demand, which subsequently impacts businesses. Given the relationship between the services PMI and the pound (as seen in the other article), it makes sense that unless we start to see progress in Brexit negotiations, businesses will be impacted by a decline in consumer confidence. This in turn will likely provide a drag on the pound.

Obviously, it is also key to see the pathway the Bank of England (BoE) take, given the current market perception that we will see a November rate hike. Whether the negotiations improve or not remains to be seen, as does the pathway of the BoE. However, it makes sense to keep an eye on the public perception of those negotiations as they could impact consumer confidence, which would knock the PMI numbers, which would in turn impact the value of the pound.

The GBP/USD chart below shows a clear bullish breakout in recent weeks, with a push above the $1.3445 resistance. However, keep an eye out for trendline resistance and the 61.8% retracement as the next hurdles. Bearish divergence on the weekly timeframe could highlight a possible retracement. However, while we could see further upside in the coming months given the possible actions of the BoE (or not), the outcome of the Brexit negotiations is likely to play an increasingly important role in market sentiment for the pound over the coming year.

Will Brexit roadblocks stifle GBP recovery?

Confidence v PMI chart

GBP/USD chart

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