Sterling recovered from its worst week against the euro in nine months on Monday as investors took profit on gains for the single currency and ministers talked up a transitional deal to smooth Britain's exit from the European Union.
The pound lost more than 2.5 percent against the euro last week, hitting an eight-month low of 89.94 pence on Friday, as the single currency rallied on bets the European Central Bank would tighten monetary policy next year. Though the pound had been supported in recent weeks by expectations that the Bank of England, too, would raise interest rates in the coming months, policymakers have made it clear that any tightening will be data-dependent. Weak figures on the British economy last week, therefore, fed doubt that the BoE was getting close to raising rates and the IMF on Monday cut its forecasts for growth this year, citing weakness in the first quarter. Against that are signs of a softening in the government's approach to Brexit that might protect British industry from the fallout of what many investors worry will be a disorderly departure from the trading bloc.
British trade minister Liam Fox said on Sunday that he backed a transition agreement to smooth Britain's departure and his colleague, business secretary Greg Clark, said he expected it would be discussed later this year. "It has been quite quiet, but people are paying attention to the Brexit mood music," said a dealer with one international bank in London. Having reached a 10-month high of $1.3111 last week as the dollar weakened across the board on political worries and falling expectations of another rate hike from the US Federal Reserve this year, sterling gained a third of a cent to $1.3046 on Monday. Against the euro, it rose 0.6 percent to 89.24 pence per euro. "The tone is very dollar-bearish at the moment, and the fact that cable (sterling/dollar) is actually marginally lower over the past week tells you a lot," said BNY Mellon currency strategist Neil Mellor. "Politics seems to be the thing right now - it was underlying economic fundamentals but I think that's starting to sour," he added. "It will be very hard, in view of the data we've had of late, to really justify a further vote for a hike." Data released late on Friday showed investors cut net short positions - or bets against sterling - to the lowest level since March 2016 in the week to last Tuesday, reflecting a souring of sentiment around the dollar as well as some optimism that the political situation in Britain could stabilise.
"We still expect sterling/dollar to take one further leg up as investors price in the May government accepting a longer-term transition, or as PM May calls it the 'implementation phase,' which will reduce the cliff edge risk for 2019," wrote Morgan Stanley analysts in a note to clients. "However, the next leg up...is for sale," they continued. "The economy seems headed for a sharp slowdown as investment and consumption both worsen simultaneously... Near $1.33, sterling will turn into a strategic sell."
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