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The key driver of recent GBP weakness has been an increasingly hardline stance by the new PM on Brexit negotiations as evident in ramping up of preparations for a possible “no-deal” outcome, Gove indicating that “no deal is now a very real prospect”, Boris Johnson’s office hinting that the next round of Brexit talks might not happen at all and apparent insensitivity of the government to recent GBP weakening.
News around PM Johnson’s meetings with Merkel and Macron ahead of G7 were closely watched this week but delivered little new information. Prior to the meetings, PM Johnson released a letter to European Council president Tusk, proposing to replace the Irish backstop with a commitment to put in place “alternative arrangements” before the end of any transition period.
The content was nothing new relative to comments Johnson has already made on rejecting the backstop, although our rates strategists note that the wording that post-Brexit laws and regulations of the UK “will potentially diverge from those of the EU” is harder than the post-Brexit relationship May had sought. The subsequent meeting with Merkel was viewed by some as indicating a softer stance from Germany, but the economists note that her comments did not indicate that she was open to changes in the WA and that the onus was on the UK to come up with solutions (within 30 days). Macron, as expected, took a harder line. It is highly unlikely in our view that the EU will reopen negotiations on the Withdrawal Agreement and will not accept Johnson’s proposals for the Irish border using alternative arrangements based on mutual recognition.
The expectation is for Johnson to blame the failure of his attempts to renegotiate on a lack of cooperation from the EU once parliament reconvenes in early September which should see risks of FX market pricing in greater odds of no-deal in September as a clear path to blocking this path through parliament won’t be immediately obvious, even as no-deal rhetoric steps up.
Trade tip: Stay short a 2M GBPUSD 30d/10d bear put spread at the beginning of August (spot reference: 1.2152). Paid 0.66%. Marked at +0.42% Courtesy: JPM
