- Three scenarios exist on GBP outlook

- Under two, GBP trades below current spot levels

- "FX is likely to bear the brunt of the uncertainty" - Soc Gen's Juckes

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The British Pound would be vulnerable to a sizeable sell-off should a potent cocktail of a 'no deal' Brexit and a covid-19 slump combine towards the end of 2020, according to analysis from Société Générale.

"Sterling is particularly vulnerable to a poor global backdrop. Brexit was never going to be easy for the economy, and with the risk of no trade deal or only a de minimis one being agreed with the EU before the end of the year, the UK has more economic downside than most and Sterling could be vulnerable," says Kit Juckes, Global Head of G10 Strategy at Soc Gen.

The call comes ahead of the July round of Brexit trade negotiations, which represent an intensification of the negotiation process.

The two sides remain far apart on the issue of the UK following a number of EU rules that would ensure UK businesses do not benefit at the expense of their EU counterparts (level playing field provisions). Another key area of disagreement is that of fisheries, with the EU wanting to maintain current access levels to UK waters.

"As newsflow around Brexit increases over the next few months, we believe that FX is likely to bear the brunt of the uncertainty while internationally-exposed large-cap stocks should remain relatively insulated," says Juckes.

Foreign exchange markets will focus on headlines regarding Brexit trade negotiations in July, but October now appears to be a crucial date in the Brexit calendar, with EU Chief Negotiator Michel Barnier saying this week that "the real moment of truth will be in October."

We expect markets to bet on an increase in Sterling volatility around this time which would likely involve a two-day European Council summit that should see EU leaders convene to try and thrash out a deal, anticipation of the outcome would likely keep the Pound relatively subdued over coming months.

Soc Gen economists attribute a "non-trivial" 17% probability to a no-deal scenario.

"Brexit and COVID-19 were both bad ideas, but only one was a choice. Doing both at the same time is challenging. Doing both as the world enters an L-shaped economic context while a vaccine fails to materialise would be a really bad idea and Sterling would feel it," says Juckes.

Under a worst-case scenario, Soc Gen says the Pound would be subject to a 'no deal' Brexit and a L-shaped recovery from the coronacrisis, i.e. the economy fails to bounce back from the damage inflicted by lockdown.

"EUR/USD would languish at the lower end of the recent range, and EUR/GBP would test the highest levels of the past few years. GBP/USD would probably head towards 1.15," says Juckes.

Soc Gen forecast a move above EUR/GBP 0.95 under the worst-case scenario and a new all-time GBP/JPY low below 110. EUR/GBP at 0.95 gives a Pound-to-Euro exchange rate of 1.0526.

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An alternative scenario for Sterling would be that the post-covid recovery is sharp and decisive, in which case Sterling stands to outperform expectations. Under a v-shaped recovery from the coronacrisis, GBP/USD "might get close to 1.40," says Juckes.

However, Société Générale's base-case scenario falls somewhere in between the above-mentioned worst- and best-case outcomes.

The GBP/USD is forecast by Soc Gen to trade at 1.22 by the end of the third quarter 2020, 1.23 by year-end and 1.24 by the end of the first quarter 2021.

EUR/GBP is forecast at 0.91, 0.92 and 0.92 for the respective timeframes. This gives a Pound-to-Euro exchange rate of 1.0990 and 1.0870.