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What will happen to sterling when Theresa May triggers Article 50?

City A.M. Monday, 13 March 2017 ()
What will happen to sterling when Theresa May triggers Article 50?Now the Budget is out of the way with barely a mention of Brexit, currency traders’ attentions can turn to the next big set piece event in the political calendar: the point Prime Minister Theresa May triggers Article 50.

May could send notification to the EU as soon as tomorrow if MPs in the House of Commons vote down amendments from the House of Lords.

Following the provisions of the article (from the Lisbon Treaty) will officially start the process of the UK leaving the EU, the topic which has dominated sterling’s prospects since 23 June.

*Read more*: The House of Lords just handed Theresa May a second defeat on Brexit

The pound hit its lowest point since January last week as the House of Lords debated amendments to the Article 50 bill. Its last visit below $1.22 against the US dollar came before Prime Minister Theresa May announced the UK will leave the EU’s Single Market, although it has since recovered to trade at $1.2216.

Yet the consensus is that the triggering of Article 50 itself will not be the shock that events of the past few months might imply.

*Appropriate pricing*

Jasper Lawler, senior market analyst at London Capital Group, says: “The actual triggering of Article 50 is not going to be the cause of some calamitous movement.”

Some volatility is to be expected, as around any big political event. The pound could make a knee-jerk movement as the Prime Minister Theresa May announces she has notified the EU of the UK’s decision to leave, followed by some profit taking, Lawler says.

It is difficult for an event which will be so heavily choreographed to come as a shock to markets, says Connor Campbell, analyst at Spread Ex.

Indeed, the start of the official negotiation process (rather than the current cross-continental shadow boxing) could mark less sensitivity in the currency to every last utterance of obscure European politicians.

*Hot blood*

However, more important than the actual triggering could be the response of European politicians over the next days, weeks, and months.

Chris Beauchamp, an analyst at IG, warns “we could get a more dramatic response from the EU than expected”, depending to a certain extent on the manner in which it is announced.

Joel Kruger, foreign exchange strategist at LMAX Exchange, says: “Once we trigger there’s going to be a lot of hot blood between the UK and the EU.”

Signs of a deal being harder to reach from EU politicians will definitely affect investor sentiment, says Kruger, but so far “there’s no new issue that hasn’t emerged since the Brexit analysis before the vote.” Risks of the pound falling below $1.15 are low at this point, he says.

*Read more*: Six risks of Brexit "no deal" after Article 50, as MPs warn May to plan now

What the trigger will do, however, is firm up plans, with a definite negotiation period and the prospect of a rollercoaster late 2018.

Chris Bailey, European strategist at Raymond James, said: “Article 50 is only the prelude to the real travelling and arriving” for the journey out of the EU.

*Looking across the pond*

However, with the meat of negotiations far ahead, investor attention will inevitably turn to the prospects for the Federal Reserve to raise interest rates when their Open Market Committee (FOMC) meets tomorrow and Wednesday, with the announcement due at 7pm UK time.

“Shorter-term in the States it’s all about the Fed,” says Bailey. “The market at the moment is ok with the Fed tightening a bit.”

The chances of an interest rate rise implied by the movement of federal fund futures are approaching 90 per cent, according to CME Group’s calculations, with other measures indicating an even higher probability.

*Read more*: Fed policymakers prepare to hike interest rates “fairly soon”

A higher federal funds rate would likely lead to a strengthening dollar, and a consequent sell-off in sterling. Although a shock hold from the Fed could equally cause a resurgence in the pound.

Over the longer term investor judgements of the pound’s value will continue to hinge on the prospects for the UK’s trading relationships around the world.

“If we start to see a softer type of Brexit the pound will recover,” says Kruger. “Longer-term the valuations are attractive for the pound.”

If a trade deal doesn’t collapse over the next two years sterling could see a further recovery, says Bailey, with a “fair value” of $1.35 to the pound – a level last seen in June.
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