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The British pound has risen the most in six months on speculation that successful Brexit trade talks this week could help protect Britain from a breakout with the EU.
The UK currency outperformed major currencies and rose as much as 1.4% to $ 1.2930 as markets took in a more conciliatory tone from officials on both sides.
Some investors are betting that despite some lingering tensions, the UK is in no position to pursue the risky policy for much longer.
“Given that we are in the middle of the Covid crisis, I think it is well understood that the UK cannot follow through on a threat to terminate without a deal,” said Mark Dowding, chief investment officer at BlueBay Asset Management.
“Our feeling was that the UK government would always try to create an impression of crisis, so that when they come to an agreement (even a very close one) they can announce it as a triumph,” he said.
Britain risks exiting the EU single market without a trade deal by the end of the year if no deal is reached.
The EU’s top Brexit negotiator Michel Barnier and his British counterpart David Frost will hold a final round of discussions scheduled to begin on Tuesday.
If they make enough progress by Friday, they could embark on a two-week period of intense discussions – the so-called Brussels “tunnel” – to reach an agreement in time for a summit of EU leaders on October 15.
Mr. Dowding predicts an agreement “in principle” within two weeks.
It went long on the pound and expects the pound to rebound around 3% to 88 pence against the euro in mid-October.
The pound is being boosted by hopes on both sides that a deal is in the offing, said Jane Foley, head of foreign exchange strategy at Rabobank in London.
A deal could raise the pound nearly 2% to 89 pence per euro in October, he said.
The outlook for the currency has also improved after the EU allowed banks to continue using London’s clearing houses next year, helping to avoid a gulf scenario for financial services.
However, “even if there is a deal, there are likely to be several gaps and this could disrupt any relief recovery,” Foley said, adding that the lack of a deal could drag the British pound to 92 pence against the euro.
Even if tensions are thawing, they still have a way to go.
The EU renewed its threat to take legal action against the UK for its plan to violate the Brexit divorce deal, saying the move was a serious violation of international law.
However, the scheduled final round of Brexit talks appears to be fueling optimism among hedge funds, according to a Europe-based trader.
This is reflected in the month-long bearish bets retreating from the highs they saw in mid-September.
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