December 19, 2019 / 9:48 AM / a month ago

Sterling finds floor around $1.31 amid renewed worries of a no-deal Brexit

* Graphic: World FX rates in 2019 tmsnrt.rs/2egbfVh

* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv

By Olga Cotaga

LONDON, Dec 19 (Reuters) - Sterling stabilised on Thursday around $1.31, after giving back all of its post-election gains on fears that Britain may leave the European Union without a trade deal by the end of next year.

The British currency had initially surged to above $1.35 last week on the back of the Conservative Party’s win in the general election.

A majority in parliament will allow Prime Minister Boris Johnson to end three years of political paralysis and take Britain out of the EU in an orderly manner in a matter of weeks.

Days later, however, that optimism waned as investors grew wary again of the possibility of a no-deal Brexit.

Johnson set a hard deadline of December 2020 to reach a new trade deal with the EU, betting that the prospect of another Brexit cliff-edge would force Brussels to move more quickly than usual to seal an accord.

After Britain formally leaves the EU on Jan. 31, it enters a transition period in which it remains an EU member in all but name while both sides try to hammer out a deal on their post-Brexit relationship.

The pound was last trading neutral at $1.3089 and at 85.05 pence against the euro, around the same levels it was before it became clear last Thursday that Johnson had won an overwhelming majority.

Implied volatility gauges for long-term maturities have risen slightly, but still remained around the lowest for this year, suggesting investors were not hurried to protect themselves against unexpected swings in the currency.

“If political uncertainty does increase in the UK, both business and consumer confidence can be expected to be impacted,” said Jane Foley, senior currency strategist at Rabobank.

“Consequently, the market is likely to conclude that the probability of a dovish Bank of England in 2020 will also increase,” Foley said.

For now, however, the BoE is likely to stay on hold and keep the interest rate at 0.75%, all 69 economists polled by Reuters predicted.

The BoE decision is due at 1200 GMT.

NO-DEAL BREXIT?

European leaders said during an EU Summit last week it would be challenging to agree on a post-Brexit trade deal by the end of 2020.

Canadian bank BMO assigns a 35% probability of a hard Brexit, while Nordea analysts see the chances of a no-deal Brexit at 20%.

Fears of a disorderly exit turned some big banks like Deutsche Bank negative on sterling as they do not see the approach of writing an exit date of Dec. 2020 into the Withdrawal Agreement putting pressure on Brussels to come to a quick agreement.

“Unless Prime Minister Boris Johnson was to pivot early on Brexit, providing certainty for businesses that the transition period would be extended and uncertainty diminish, recession risks would likely crystallise. Unfortunately, a downturn now seems likely,” said Oliver Harvey, macro strategist at Deutsche Bank.

Others have remained positive on the pound.

“Exchange-rate drops into the lower end of the sterling/dollar $1.30–$1.40 range can be used to build exposure to sterling,” said Mark Haefele, Chief Investment Officer, UBS Global Wealth Management.

“Fading dollar demand and a clear path toward a benign free trade agreement with the EU could see sterling/dollar rallying to $1.45 by end-2020,” he said. (Reporting by Olga Cotaga Additional reporting Tommy Reggiori Wilkes Editing by Robert Birsel)

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