December 2, 2016 / 4:35 PM / a year ago

INVESTMENT FOCUS-Back to Brexit for sterling

* Sterling up 5 percent in November after 4-month fall

* Court case may affect perception of hard or soft Brexit

* Market positioning carries risk of short squeeze

By Patrick Graham and Jamie McGeever

LONDON, Dec 2 (Reuters) - It has been a difficult week for investors betting against sterling on worries about the shape of Britain’s exit from the European Union. And next week’s Supreme Court hearing on parliament’s role in proceedings may only make things worse.

In the space of a few hours on Thursday, the pound surged to its highest in almost three months against the euro and its highest in two against the dollar.

Brexit Minister David Davis was the trigger, hinting for the first time that the government could contribute to the EU budget in exchange for retaining more privileges in the bloc’s single market.

That was not a commitment to stay inside the single market, but it sounded like the sort of concession that might lead London to a compromise less damaging to its banks, businesses and economy than some investors had feared.

It followed a month when domestic politics and economics have played steadily in favour of the pound, and the focus on events in the United States and on global fixed income markets has turned speculators’ eyes elsewhere.

Sterling’s value against a basket of currencies rose 5 percent in November, its biggest monthly rise since January 2009 and second biggest in more than three decades. It remains 15 percent down since this time last year.

The government also suffered defeat in a contest for a vacant parliamentary seat on Thursday which felt like an anti-Brexit vote. And the court case will allow its opponents to make the case again for their right to influence perceived hardliners like Davis.

With short positioning in sterling still close to record lows and the proximity of year-end accounting, some of those who bet in July and August on depreciation seem to have cashed in and walked away.

“For the first time in weeks, domestic issues are driving sterling,” said Jordan Rochester, G10 currency strategist at Nomura in London. “I expect a lot of noise, and because market positioning is still very short, the risks are always for a potential squeeze to the upside.”


The court has said a decision is unlikely to come until after the New Year. But the live broadcast of the hearings - unusual in Britain’s legal system - may see more political theatre.

The initial ruling a month ago, against which the government is appealing, said it needed to allow parliament a vote before launching its divorce from the EU by triggering Article 50 of the Lisbon Treaty.

That sent sterling 1.5 percent higher and offered hope to those arguing for a “soft Brexit” that prioritises a close economic relationship with Europe over tighter controls on immigration.

“What the market liked about the ruling was that in one sense it raised the probability of delay,” said Barclays strategist Hamish Pepper. “With a longer period of time to consider a policy and a negotiating stance, you might end up with something that has a greater chance of being successful.”

If the government loses again, it will have to secure some form of parliamentary approval to trigger Article 50.

This could be achieved through a substantive motion - a proposal put forward for debate and a vote - which would take little time. However, the claimants say there needs to be new primary legislation that passes through both parliamentary chambers, a far more complicated process.

That could make it hard for Prime Minister Theresa May to meet her target of invoking Article 50 by the end of March.

Yet some analysts argue the ruling has broader consequences than just the timetable.

“The market appears to be leaning towards the government’s appeal not being upheld, and therefore (triggering) Article 50 means (seeking) parliamentary approval,” said HSBC strategist Dominic Bunning. “That means a softer Brexit.”

The pound fell from $1.50 to $1.30 in the three months after the vote in June. Only the last leg of the fall, since the prime minister delivered a speech in October that was interpreted as pointing towards “hard Brexit”, has been driven by speculation on the likely terms of the departure.

That points to a return from current levels around $1.2680, first to key resistance around $1.28 and then higher if a “soft Brexit” looks increasingly likely.

“Sterling itself is undervalued,” said James Kwok, head of currencies for asset manager Amundi.

“It should be trading about $1.30. It is trading lower because of all the uncertainty. But for us the best way is not to bet on cable (dollar rates), but to bet against the euro.” (Writing by Patrick Graham; Editing by Mark Trevelyan)

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