Sterling steadied near a one-week high on Tuesday, holding on to a more than 1 percent rise against the dollar the previous day on the view that Britain’s exit from the European Union will be slower — and softer — than had been feared.
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The pound jumped above $1.25 on Monday after Prime Minister Theresa May pledged to address business concerns that Britain could fall off a “cliff edge” into uncertain trading conditions when it leaves the bloc, hinting at some form of a transitional agreement.
That was the strongest signal yet that May might be open to a deal that would offer Britain time to forge a new trading relationship with the EU when formal divorce talks are concluded, probably in 2019. “If the government were to stick to a two-year deadline that would be unlikely to result in any kind of agreement, so that would be likely to lead to a really hard Brexit, so this transitional arrangement is positive,” said Societe Generale currency strategist Alvin Tan.
“If the final agreement takes five years, as some are saying, or even seven years, like the Canada-EU trade agreement, then the transitional arrangement is what markets are going to be focused on. Five to seven years is further than most people’s horizons when it comes to financial markets.”
Sterling climbed to as high as $1.2514 in Asian trade, its strongest in a week, before easing back to around $1.2490 by 0930 GMT, flat on the day. Against the euro, it edged down 0.2 percent to 85.26 pence , after trading below 85 pence on Monday – the pound’s strongest in two months.
Sterling was little moved by data showing Britain ran a much smaller than expected budget deficit in October. Public finances still looked weak for the year as whole. The market’s focus will now switch to Wednesday’s budget update from the British government. Finance minister Philip Hammond on Sunday played down the chances of a major new boost for spending in the autumn statement – his first in his role as head of the Treasury.
Analysts expect some modest infrastructure spending and housing stimulus on Wednesday but nothing that would radically change expectations of a weaker economy next year when difficult talks begin on the terms of Brexit. “The lack of details over the UK government’s Brexit strategy has contributed to the wild ride for the pound over the last couple of months (but) recent price action supports our view that pound weakness last month was not fundamentally justified, and driven by excessive bearish sentiment,” said MUFG currency economist Lee Hardman.
“The UK economy has been little impacted so far by the Brexit uncertainty which, if sustained, should help to further reverse bearish sentiment towards the pound.”