The pound could fall below the value of the euro for the first time in history if MPs reject Theresa May’s draft deal and a no-deal Brexit becomes more likely, according to the most bearish estimates in the City.
UK politicians are due to vote on the prime minister’s draft Brexit deal on Tuesday, 11 December. May has warned that the country could face a disastrous no-deal Brexit in March or Brexit could be cancelled all together if politicians do not approve the deal. Despite this, up to 100 Conservative MPs are said to be planning to vote against the agreement, which is widely disliked.
“Even if we assume that number falls considerably, defeat for PM May seems likely,” Robert Wood, UK Economist at Bank of America Merrill Lynch, said in a note last week.
However, despite widespread expectations that the deal will fail, the pound “has been shackled by the Brexit uncertainty” and is “locked in holding pattern” around $1.27, according to Nigel Green, the founder and CEO of financial advisory group deVere.
As a result, we could see big moves for sterling whatever the outcome of Tuesday’s vote.
What does defeat mean for sterling?
Analysts expect the pound to fall if May’s deal is rejected as it would crystallise the threat of a no-deal Brexit.
UBS said in a note last week that the euro could actually surpass the pound in value for the first time if the deal is rejected.
“We think EUR/GBP could trade well above parity in a ‘no-deal’ scenario,” FX strategist Lefteris Farmakis and his team at UBS wrote in a note last week. “We believe risks for ‘no-deal Brexit’ remain elevated in light of a challenging parliamentary arithmetic [for Theresa May’s Brexit deal].”
Farmakis said he expected parliament to approve some form of amended second deal, but that this may only happen if there is further pressure on the pound, driven by no-deal fears.
“Market pressure [is] likely required for a vote pass on a second attempt. Thus, things could get worse before they get better,” Farmakis and his team wrote.
The euro is currently trading against the pound at around 0.88, implying a rally of around 13% against the pound in Farmakis’ no-deal scenario. The currency has never surpassed sterling in value since the euro’s creation in 1999.
UBS is one of the most bearish houses on the pound but most analysts expect a decline.
Chris Turner, global head of strategy at ING, said in a recent note to clients: “We think EUR/GBP could still have another run at the 0.91/0.92 area by the end of this year as PM May struggles to get her Withdrawal Agreement through parliament at the first attempt.”
Dominic Bunning, a senior FX strategist at HSBC, wrote in a note to clients last week that the pound would likely remain “range bound” against the dollar if the deal is rejected but would shift “into a slightly lower range around 1.25.”
Strategists surveyed by Bloomberg forecast that the pound will fall to $1.25 from its current price of $1.27 if May’s deal is rejected, implying a fall of about 1.8%.
A poll of Nomura clients found an average forecast a fall of 2.6% for the pound against the dollar if the deal is rejected and an expected rally for sterling of 3.6% against the dollar.
ING’s Turner told Yahoo Finance UK that the precise magnitude of the pound’s fall would depend on how many votes May’s deal is defeated by.
“People will be looking at the degree to which she loses that first vote, the margin,” he said.
What does approval mean for the pound?
In the unlikely event that the deal does pass through the House of Commons, most analysts think upside will be limited.
“It’s trying to thread the eye of the needle for a bullish set of outcomes for sterling,” Turner told Yahoo Finance UK.
He forecast a maximum 2% bounce for the pound and said this would only occur if a second referendum became more likely. UBS’ Farmakis forecast a similar rise in the event of approval.
HSBC’s Bunning is more bullish. He told clients in a note: “GBP would rally sharply, as no-deal risks would vanish and cyclical forces would dominate again.” He forecast the pound would eventually hit $1.38, while the euro would drop to 0.82 against the pound, implying moves of 8% and 6% from today’s prices.
Whatever the outcome of the vote, Turner said: “All that we should assume is continued very high levels of volatility.”