Unease about Brexit negotiations dents sterling again

Sterling dropped below $1.30 for the second time since the UK referendum

By Jon Sindreu/ The Wall Street Journal

A steady trickle of news highlighting the UK’s uncertain future relationship with the European Union is weighing on sterling, which Tuesday slid below $1.30 for the second time since the Brexit vote. In the early European afternoon, the pound hit its lowest since August, trading as low as $1.296. The British currency has been on a downward trajectory against other major currencies for the last two weeks.

After Britons voted to leave the EU in June, sterling plunged 12% to its lowest level since 1986, but better-than-expected economic data since the vote had recently fuelled a small rebound. At the beginning of September, investors lowered their expectations for how much monetary easing the Bank of England would need to deliver.

As a result, the pound reached $1.34, its highest level since June. Hedge funds had even begun to reduce their bets on sterling going lower, while banks rowed back their bearish forecasts.

However, the last two weeks have provided investors with a wake-up call about how undefined Britain’s future actually is, driving sterling to stumble again.

In an appearance before lawmakers last week, the UK’s Brexit minister, David Davis, avoided giving an official position on what relationship the government wants to pursue with the bloc.

His own positions on the issue have clashed with Prime Minister Theresa May’s: In the run up to the Brexit vote Mr. Davis had campaigned for the UK to leave the EU, whereas Ms. May had been quietly with the remain camp. But even after Ms. May conceded that “Brexit means Brexit,” they’ve appeared to differ over the UK’s future access to the single European market.

And it’s not only the UK that is exhibiting a lack of unity on the way forward. This weekend, EU leaders met in Slovakia—without UK Prime Minister Theresa May—to coordinate their response to Brexit, but the summit highlighted cracks between those countries seeking a tighter relationship with Britain and those wanting to enforce the costs of leaving the bloc.

Stephen Gallo, European head of currency strategy at BMO Capital Markets, believes Britain will eventually strike a good deal with European officials and sterling will recover much of its former strength. In the meantime, however, uncertainty will continue to batter it.“ It’s going to be treated like an unloved emerging-market currency,” he said. Many investors aren’t as optimistic as Mr. Gallo about the outcome of the negotiations. They fear U.K. financial companies could lose the so-called “financial passport” which gives them the right to sell their services freely to the EU’s single market. Such a loss would be a blow for the City of London’s financial industry, impacting the U.K. economy overall, analysts say.

“There’s nothing in the positive data flow through July and August to cause one to change one’s mind about the longer-term economic damage from Brexit,” said Paul Meggyesi, analyst at J.P. Morgan Chase & Co. To be sure, economists argue that a lower pound could itself be beneficial for economic activity, because it makes it easier for British exporters to sell their products abroad. Still, the magnitude of this effect is hard to pin down and is unlikely to materialize fast.

“Past experience shows that it takes two years for swings in sterling materially to affect GDP growth,” said Samuel Tombs, analyst at Pantheon Macroeconomics.