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UPDATE 2-Sterling stabilises; Brexit 'mood music' brightens

* Graphic: World FX rates in 2020 tmsnrt.rs/2egbfVh

* Graphic: Trade-weighted sterling since Brexit vote tmsnrt.rs/2hwV9Hv (Updates prices)

LONDON, Oct 8 (Reuters) - Sterling stabilised on Thursday as prospects for a Brexit deal appeared to improve, with Britain giving it a 66% chance of success.

The pound inched up towards $1.30 in early session, before giving back those gains. Against the euro, sterling strengthened slightly. A Bloomberg News report suggested officials might be more optimistic than they were letting on in public.

British Prime Minister Boris Johnson and European Council President Charles Michel agreed on Wednesday that some progress had been made in talks on a trade deal, though significant differences remained.

On top of that, analysts said the Bloomberg News report suggesting that in private officials were more optimistic about the likelihood of clinching a deal had helped sentiment.

“In any case, next week’s EU Council meeting is not the hard deadline we had thought it would be but rather yet another ‘stock-taking exercise’,” said Marshal Gittler, head of research at BDSwiss.

The pound was last trading flat against the U.S. dollar at $1.2920 and up 0.2% versus the common currency at 90.88 pence.

The week has proven volatile for the British currency with contradictory Brexit headlines flying around as Britain and the EU negotiate their future relationship.

An overnight rise in implied volatility gauges to a two-month high of above 12% in sterling, suggested traders were prepared for more unexpected moves as talks continue .

“The improving mood music surrounding the Brexit talks is encouraging a stronger pound,” said Lee Hardman, currency analyst at MUFG. However, coronavirus concerns could cap the currency, he added.

“The more severe the lockdown becomes the more likely positive Brexit developments will be overshadowed,” he said.

The British government is considering additional local COVID-19 restrictions for parts of northern England as the second wave of infections accelerates.

Bank of England Governor Andrew Bailey said he did not expect the new wave to be as damaging as the first and voiced optimism about the Brexit deal’s prospects.

He also said the central bank was ready to use its policy firepower to limit the impact of a second wave.

Bank of America analysts said “investors are under-pricing no-deal risks”.

“Though a deal remains our base case we argue that this is no longer the binary outcome for the pound that it was once,” the analysts said, giving as explanation that “UK red lines prevent a deep and comprehensive relationship with the EU” and that a deal would still represent a hard Brexit. (Reporting by Olga Cotaga Editing by Tomasz Janowski, Raissa Kasolowsky and Alison Williams)

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