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- Pound is 2019's top performing major currency

- UniCredit called the GBP/EUR rally in Jan. trade recommendation

- But now say rally is due a pause

Pound Sterling's 2019 rally against the Euro has come to an end, at least for now, and those watching the GBP/EUR exchange rate should be wary of a reversal says currency strategist Katherin Goretzki at UniCredit Bank in London.

At the time of writing 2019's gains in GBP/EUR stand at 4.66%, but it was back in January that Goretzki recommended clients of the Milan-based bank prepare for a rally in the Pound against the Euro, with the view that markets would increasingly adopt a view that a 'no deal' Brexit was becoming increasingly unlikely.

When the call was made on January 11, the Pound-to-Euro exchange rate was quoted at 1.1168, according to Bank of England data. The Pound-to-Euro exchange rate is quoted at 1.1616 at the time of writing, however the pair had been as high as 1.1727 last week, a two-year high, when Goretzki advised she was exiting the trade. The gains for Sterling came as markets increased bets that a 'no deal' was an unlikely scenario after Prime Minister Theresa May opted to give parliament a vote on delaying Brexit should her deal fail to get passed before March 29.

The reading by Goretzki of Sterling markets and the political landscape driving the currency's valuation has therefore proven to be astute.

Goretzki recommends traders take profit on the trade, "in line with our expectations, markets are now pricing in a higher probability that a deal could be reached earlier than the market expected in January."

"We continue to see a more-than-50% chance of a deal being reached by the end of March, which should open up room for further GBP appreciation below 0.85 in our baseline scenario," says Goretzi.

EUR/GBP at 0.85 equates to GBP/EUR at 1.1628.

"That said, following the recent GBP rally, we see risks of a correction," says Goretzki. "Since recent political developments have further reduced the risk of a no-deal Brexit, and now that a deal by the end of March has become more likely, focus has now shifted towards the question of whether the next couple of weeks will bring a deal (and a short extension of the timeline associated with Article 50 of the Lisbon Treaty for technical reasons) or an extension and further discussions."

The Pound was further boosted this week on reports that any delay to Brexit could last up to two years, suggesting markets like the idea of a long-term delay that provides businesses with certainty.

According to a report carried in the Evening Standard, UK ministers believe a "short, limited extension" of Article 50, as suggested by Theresa May in the House of Commons on Tuesday, would not be permitted by Brussels in the event of no deal being agreed by the UK parliament, instead the EU would likely opt for a longer extension.

The news was snatched upon by traders who bid Sterling higher: the Pound-to-Euro exchange rate rallied to a record a fresh two-year high at 1.1727 on Wednesday, before fading those gains to quote at 1.1681 at the present time. The Pound-to-Dollar exchange rate rallied to record its highest level since July 2018 at 1.3348, before paring gains to trade at 1.3298.

However, Goretzki's reading of the situation is that a delay could play negative for Sterling as it only compounds uncertainty. We also note a number of analysts suggesting that there is a significant difference between a long-term delay and shorter three-month delay being proposed by Prime Minister May.

A shorter variant merely pushes back the 'no deal' Brexit deadline, kicking a concern for markets a little further down the road.

"In our view, a possible extension prolonging Brexit-related uncertainty poses risks of a correction after the recent rally in GBP. Therefore, we prefer to close our trade recommendation, booking a net profit of 0.67%," says Goretzki.

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Services PMI Data Beats Expectations, but Masks Over Growing Problems for Economy

The IHS Markit Services PMI read at 51.3, well ahead of the 49.9 economists and the market had been expecting.

As is often the case when this data comes in above expectations, the British Pound rallied.

Looking at the initial reaction in the Pound-to-Euro exchange rate, we can see a bounce from 1.1622 to 1.1638 in the minute of the data's release. The Pound-to-Dollar exchange rate went from 1.3167 to record a high of 1.3190 in the same minute.

Despite the initial positive reaction we would caution readers that the move could be algorithmic with many trading systems simply prompting a buy or sell on any meaningful deviation away from an expected data point.

We would not be surprised to see Sterling settle back to levels seen ahead of the data release, particularly as the details contained in the PMI report are not quite as rosy as the headline number suggests.

Despite the services sector - which accounts for over 80% of the UK economy - growing, reports from survey respondents suggested that Brexit-related uncertainty remained by far the most prominent factor acting as a brake on business activity growth in February.

There are also some worry developments buried in the data.

According to IHS Markit, employment numbers declined at the fastest pace for over seven years as businesses opted to delay staff hiring in response to subdued demand and concerns about the near-term economic outlook.

The findings on employment echoed a similar report on employment losses reported in the Manufacturing PMI released on Friday, March 01.

Falling employment levels are negative for the Pound in the longer-run as it suggests easing pressure on the Bank of England to raise interest rates. The Bank of England tends to raise interest rates in response to a strong labour market, and higher interest rates in turn attract foreign investor flows that support the value of Sterling.

"The UK PMI avoided slipping into contractionary territory in February, but the underlying details make it clear the economy is stalling as firms continue to batten down the hatches ahead of Brexit," says James Smith, Developed Markets Economist with ING Bank N.V. in London. "The bottom line is that growth will continue to stall over coming weeks, particularly as we may not get complete certainty on the possible Article 50 extension until a little over a week before the 29 March deadline."

If a Brexit deal is reached this month we would be interested to see if this drop in employment is a blip, or the start of a cyclical downturn in the labour market.

Optimism amongst UK businesses is downbeat, and we will also be looking for a boost should a deal be passed.

"UK business optimism regarding the next 12 months has sunk to the lowest ever recorded by the PMI surveys with the exceptions of the height of the global financial crisis and July 2016," says Chris Willamson, economist with IHS Markit.

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