It wasn’t that long ago that the slightest Brexit comment from a middling UK or European politician would send investors into a flap and toss the pound around the foreign exchange market like leaves on a windswept afternoon.
Sterling is made of sterner stuff these days. Theresa May, the UK prime minister, was drawn into a verbal spat with the European Union, accusing “European politicians and officials” of attempting to influence next month’s general election.
The pound swayed but held its ground. A highly significant break through $1.30, a level last reached in September, looks inevitable.
“It certainly feels that way,” says Adam Cole of RBC Capital Markets. The trigger could come from a weaker dollar but, in any event, “sterling is independently strengthening”, says Mr Cole. Also helping a push above $1.30 is the prospect of bearish bets against the currency being closed, requiring the purchase of pounds in the foreign exchange market.
Investors have not simply closed their ears to Brexit and its incessant noise. There are plenty of sterling-watchers still bothered about its potential impact on market sentiment. MUFG is upbeat about the pound’s prospects, but forex analyst Derek Halpenny warns that if Brexit tensions do not recede, “we may see some softness emerge for the pound over the short term”.
Commerzbank would rather sell than buy the pound because of the unflinching Brexit positions on both sides of the English Channel, while Commonwealth Bank of Australia says there are downside risks for sterling “if the political dogfighting continues”.
Yet there is an undeniable shift in investors’ sterling outlook. This was a market that not so long ago had record levels of outstanding trades betting against the pound, or “shorts”.
Once Article 50 was triggered at the end March, the mood eased.
At that point, says Sam Lynton-Brown of BNP Paribas, “the bearish newsflow slowed down and those investors who were short had no impetus to hold on to those positions”.
They began to squeeze them, a process accelerated by the prime minister’s decision to call a snap election. By creating a three-year gap between the 2019 Brexit negotiations deadline and the next election, Mrs May at a stroke neutralised investor fears of a disorderly exit.
Short sterling positions tracked by BNP have been “wiped out”, Mr Lynton-Brown says, while the options market is back to January levels, as measured by three-month implied volatility in sterling against the dollar.
In the absence of concrete Brexit news, he adds, sterling should be “relatively insensitive” to the shrills of negotiations rhetoric.
That creates space for investors to judge sterling against UK data that have been “extraordinarily good”, says Richard Benson of institutional asset manager Millennium Global.
This week has been characterised by sharp intraday moves higher in the pound following surprisingly positive surveys of purchasing managers in the services, manufacturing and construction sectors. Sterling may also respond positively if the election campaign continues to point the way to an enhanced parliamentary majority for Mrs May.
The pound had been “very sensitive to UK political risk post-Brexit”, says Kathleen Brooks of City Index. But the economy is “playing into Theresa May’s hands”, helping to reduce political uncertainty, she adds, so a comfortable victory next month combined with a pick-up in UK economic data could help sterling break through $1.30.
Others are more circumspect. There are greater signs of growth in soft data such as purchasing manager surveys than in hard data, says economist Dean Turner at UBS Wealth Management.
Note the weaker trend in retails sales data, warns Rabobank’s Jane Foley, adding that wobbly housing data “provides another sign that consumers’ real incomes are now under pressure”.
A bigger Conservative majority looms as positive for sterling, but there is a potential negative, Mr Cole says, because “it implies tighter fiscal policy for a full five-year term, and looser monetary policy”.
That may be too far down the road for investors. Next week’s quarterly inflation report from the Bank of England is in their sights. Will the surprise UK data trigger a hawkish tone from its governor, Mark Carney?
That may be premature for some analysts, but Goldman Sachs suggests two of the eight members of the Monetary Policy Committee could vote for a rate rise. It predicts the BoE will begin to reverse some of the easy-credit measures that were part of its emergency post-Brexit policies announced in August.
Of course, investors can get carried away by good data. Trading on the momentum in the economy may be the right thing to do, says Mr Cole, “but there is a danger that expectations for the economy have been so inflated that expectations overshoot and we roll over from a positive to a negative dynamic”.
It is a bit like that with the pound. The more the market expects sterling to go higher, the greater the risk of a reverse.