Sterling turns focus back to Brexit and beyond

The British pound has seemingly shrugged off the potentially adverse prospects of the UK leaving the European Union (Brexit), as much of the market concerns over Brexit consequences have already been priced-in to the heavily-pressured pound in the past several months. Article 50, which formally launches the long and drawn-out process of UK/EU separation, is slated to be triggered on Wednesday of next week. While UK equity markets have shown some signs of buckling under Brexit concerns, the pound has risen sharply within the past two weeks against two of its primary rivals – the US dollar and the euro.

Recent sterling strength has defied the intense pressure on the UK’s currency that has been evident for many months, since the UK’s June 2016 referendum that decided its soon-to-be-realized fate. Now that the formal separation is just around the corner, the pound has decided to rally from near long-term lows against the US dollar.

Some of this recent rally can be attributed to a sharply falling dollar within the past two weeks, as a less-than-hawkish Federal Reserve combined with concerns over the Trump Administration’s ability to carry-through its fiscal policy promises have weighed heavily on the greenback.

Perhaps more critical to the pound’s recent rise, however, has been a subtle but clear shift in expectations for interest rates in the UK. This past week, consumer price inflation in the UK was shown to have risen by 2.3% - the strongest rise in nearly three-and-a-half years. In addition, the previous week saw the Bank of England keep interest rates steady, but with one critical dissenting vote. Kristin Forbes voted for a 25-basis-point hike amid concerns over rising inflation. While it was only one dissenting vote, this outcome provided an indication that the tide may indeed begin to turn hawkish if inflation continues its trajectory.

Next week, much of the markets’ focus will return to how the pound may or may not react to the formal triggering of Article 50 and beyond, especially sterling’s relative movement against the US dollar, euro, and Japanese yen. There are still many unknowns as to how the process will play out with respect to economic implications and trade agreements between the UK and EU. These unknowns for the pound will be placed against the backdrop of a currently-pressured US dollar, a recovering euro, and a surging Japanese yen.

The GBP/JPY currency pair should be a particularly important currency pair to watch at this time. Any substantially negative reaction for the pound next week, which could indeed be likely, should exacerbate the downtrend for GBP/JPY, as such a market risk may also accelerate buying of the safe-haven yen. As for GBP/USD, its trajectory will depend not only on the pound’s reaction to Brexit going forward, but also on how the dollar reacts to the Trump Administration’s successes or failures in furthering its economic agenda in the coming weeks.

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