Rishi Sunak’s Brexit deal with the EU on Northern Ireland has buoyed sterling and the currency is likely set for further gains once the agreement receives parliamentary backing, investors say.
Still, any rebound is likely to be limited by the UK’s gloomy economic outlook and resurgent inflation in Europe and the US, according to market participants.
The pound has risen by more than 1 per cent against the dollar to trade above $1.21 since the UK prime minister on Monday clinched a deal with European Commission president Ursula von der Leyen over Northern Ireland trading rules, potentially ending years of often bitter post-Brexit back and forth between the trading partners.
Success in pushing the agreement through parliament would be “unambiguously good” for sterling, said Kit Juckes, macro strategist at Société Générale. “Anything that gets [the UK] back towards a long term healthy economic and political relationship with Europe is a plus.”
Sterling slumped in the wake of the 2016 vote to leave the EU. Buffeted by successive rounds of negotiations over the UK’s future trading relationship with the bloc, it has since failed to recover the bulk of its losses.
Any sense that ties between the UK and the EU are on the mend would therefore be “potentially massive” for sterling, said Jane Foley, head of FX strategy at Rabobank.
Although the pound “tends to pay very little heed” to issues surrounding Northern Ireland, Monday’s deal suggests there is scope for more positive relations with the EU moving forward, Foley said. “This will be a slow burn” for the pound, she added. “For investors in the UK, some sort of improved relationship [with the EU] is a first step.”
Others doubt quite how much impact the deal will have for a currency whose value is determined as much by the strength of the dollar and the UK’s less than rosy economic outlook as it is by the health of London’s relationship with Brussels.
Chris Turner, global head of markets at ING, said Monday’s deal does reduce a small risk of a further deterioration in UK-EU relations that existed under former prime ministers Boris Johnson and Liz Truss, “and could be regarded as mildly positive for the pound”. “It’s not meaningful long term, however,” Turner said, with the UK economy’s sclerotic growth and stagnant productivity likely to continue to deter investors long term.
Others said stickier than expected inflation in the US and Europe could also weigh on the pound. Persistent price growth in both regions raises the chance of further interest rate increases from the Federal Reserve and European Central Bank, boosting the allure of the dollar and the euro relative to other currencies.
The Bank of England, in contrast, is widely considered to be closer than other major central banks to the end of its monetary tightening campaign.
“There is a risk that a few more rate rises are needed to cool burning [US] demand, so I’m not sure the pound can win against the Fed,” said Agnès Belaisch, a fund manager at Barings.
All other things being equal, SocGen’s Juckes said the pound could rise a further 2 or 3 per cent against the dollar if MPs back Sunak’s deal.
Ultimately, though, sterling’s next move is likely to be dictated by the broader strength or weakness of the dollar, according to Juckes. “If the euro hits parity with the dollar, sterling goes down whatever happens.”