Sterling heads higher on hopes of a Brexit trade deal

LONDON (Reuters) - Sterling gained on Monday as traders clung to hopes that Britain and the European Union will soon seal a long-awaited Brexit trade deal.

FILE PHOTO: UK pound coins plunge into water coloured with the European Union flag colours in this illustration picture, October 26, 2017. REUTERS/Dado Ruvic

The United Kingdom exits the EU’s orbit on Dec. 31, when a transition period of informal membership ends following itsformal departure last January.

The sides are trying to secure a deal to govern nearly $1 trillion in annual trade from Jan. 1 but are yet to bridge differences on fishing, state aid and how to resolve any future disputes.

British Environment Secretary George Eustice said the coming week was “crucial” for securing a breakthrough in talks, and both sides said time was running out for a deal. German Chancellor Angela Merkel said some EU member states were becoming impatient.

Even so, most sterling investors are confident the two sides will eventually agree a deal. The pound has held on to recent gains and last week hit a 2-1/2 month high.

On Monday, the British currency rose to as high as $1.3388 before falling back to trade at $1.3335 in late London trading, 0.1% higher on the session. Above $1.34 would mark a three-month high.

Against the euro, the pound extended its earlier rise as the single currency suffered a broad selloff. The euro was last down 0.3% versus sterling at 89.585 pence.

Not everyone is convinced the pound will move much higher if a trade deal is secured.

“The UK is likely to face adjustment pressures from the twin factors of COVID-19 and Brexit with or without a limited FTA (Free Trade Agreement) in place from January 1, 2021, and there is scope for more friction in the bilateral UK/EU relationship going forward,” said Stephen Gallo, European Head of FX Strategy at BMO Capital Markets.

Gallo has a one- and three-month target of $1.34.

“Regardless, the UK’s twin fiscal and current-account deficits will probably curb GBP appreciation for the time being, and their persistence could pose medium-term inflation risks to the UK economy,” he added.

Commerzbank’s Ulrich Leuchtmann noted that pricing in the options market suggested significant demand for insuring against falls in the pound. Leuchtmann does not expect much of a rise in sterling even if a deal is announced.

Reporting by Tommy Wilkes; Editing by Pravin Char, Gareth Jones and Timothy Heritage