Banks ramp up bets on Brexit deal as mood music improves

LONDON (Reuters) - Major investment banks said on Friday they had become more optimistic on the prospects for a Brexit deal, following an upbeat meeting between British and Irish leaders that buoyed the pound.

FILE PHOTO: Ireland's Prime Minister Leo Varadkar speaks during the 2019 United Nations Climate Action Summit at U.N. headquarters in New York City, New York, U.S., September 23, 2019.

Irish Prime Minister Leo Varadkar said on Thursday a withdrawal agreement could be clinched by the end of October, which would allow the United Kingdom to leave the European Union in an orderly fashion.

EU negotiator Michel Barnier and his British counterpart Stephen Barclay, meanwhile, held a “constructive” meeting on Friday, both the British and EU sides said.

The pound, British stocks, bonds, and Irish government bonds rallied as investors scrambled to cover short positions, with the British currency hitting its highest levels in more than three months. It was trading at $1.2675 at 1500 GMT.

Deutsche Bank said it was no longer negative on the pound.

“This represents a significant change of tune by the Irish government, that has so far been relatively pessimistic about the prospect of talks moving forward,” Deutsche’s foreign exchange strategist, Oliver Harvey, told clients.

JPMorgan, meanwhile, predicted a deal would be struck, noting the two sides appeared to have found a solution to the thorny Irish border issue.

The bank now sees a 50% chance of a withdrawal agreement being struck with a “modified/time-limited” Irish “backstop” that could get round a major sticking point over customs and border arrangements between Ireland and the UK province of Northern Ireland.

It had previously put the likelihood at just 5%.

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Some remain doubtful. For one, time is short and any deal British Prime Minister Boris Johnson brings back from Brussels will need the British parliament’s approval, including from hardline pro-Brexit factions.

The British government is therefore likely to request an extension to the Brexit deadline and then hold a general election, UBS Wealth Management said. But it acknowledged that the chances of a Brexit agreement had nonetheless increased.

“The chances of a deal seem to have improved and the pound has moved accordingly but hurdles still remain,” said Dean Turner, economist at the wealth manager.

“Time to thrash out the details of the deal are tight, and then there is the question of parliamentary approval.”

A deal would prolong the rally in the pound, Turner said, predicting sterling would hit $1.35 and trade in the “low 80s” against the euro if there was an agreement.

Morgan Stanley upped its chances of a Brexit deal to 55% from 35% before the latest developments. The investment bank said a deal would be negotiable if London agreed to a customs border between Northern Ireland and the rest of the United Kingdom, although it was uncertain such an arrangement would be approved by the current parliament.

“We continue to see elections as the most plausible mechanism to decide the way forward on Brexit and expect them to be held before Brexit,” the bank’s economists Jacob Nell and Brunca Skarica wrote in a note to clients.

“However, given that a Johnson government seems to have switched to supporting a negotiable deal, we now see a significantly reduced risk of a no-deal outcome after elections, since even a Johnson government would prefer an orderly exit to a no-deal outcome.”

Goldman Sachs was ahead of the bunch, however, sending a recommendation late last Friday for clients to buy sterling against the dollar, with a target of $1.30 compared with the then spot pound value of around $1.23.

It assessed the probabilities of a Brexit deal being struck at 60%.

Political risk consultancy Eurasia Group raised its probability of a Brexit deal from 5% to 10%. But barriers to one were still substantial, it cautioned.

Reporting by Josephine Mason, Olga Cotaga, Sujata Rao, Marc Jones, compiled by Ritvik Carvalho; Editing by Pravin Char and Mark Potter