-GBP could rally if Brexit deal struck but upside limited says BMO.

-Averting WTO terms to lift GBP but talks points to bare bones deal.

-‘Skinny’ FTA would shake up trade relationship and cap the GBP.

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The Pound-to-Euro rate could experience a relief rally in the event that a free trade agreement is reached with the European Union but selling into any such rebound might be the better approach, according to BMO Capital Markets.

Sterling has been bleeding lower against the Euro for months, reflecting a steady lengthening in the perceived odds of a trade deal being struck with the EU, leaving the Pound-to-Euro rate lower by nearly -4% for the three months since negotiators resumed contact in April and by -7% for the 2020 year.

Losses have been compounded by a rebounding Euro that has heaped extra pressure on Sterling since mid-May as investors rewarded the single currency for the European Commission’s now complete push for a €750bn recovery fund and changes to the way the bloc does its fiscal business.

This steady but sustained fall partially reflects a rising ‘risk premium’ that could be eliminated if a ‘no deal’ style arrangement governed by World Trade Organization terms and most-favoured-nation tariff rates is avoided.

“The tone of the negotiations currently suggests that Brexit will be on the 'harder end' of the spectrum in relation to issues such as regulatory equivalence, ECJ oversight, EU involvement in UK state aid rules, and EU access to UK fishing waters,” says Stephen Gallo, BMO's European head of FX strategy. “The 'harder' the Brexit, the more scope there will be for regulatory, fiscal and trade policy divergence between the UK and the EU-27. But a 'hard' Brexit also means that the UK/EU trading relationship will be in a state of constant evolution after the end of the transition period, thereby injecting a lot more volatility into the bilateral trade data and initially putting a cap on GBP appreciation.”

Above: Pound-to-Euro rate shown at 4-hour intervals with 21, 55 and 200-period moving-averages.

Negotiators made little progress in overcoming the key impediments to an agreement in the latest talks, negotiators confirmed on Thursday, with EU national leaders’ stances on fishing rights and its pursuit of a continued whip hand over the UK in a range of policy areas having placed Prime Minister Boris Johnson between a rock and a hard place.

The Centre for Brexit Policy is calling for repudiation of the WA. All Tory Brexiteers need to get behind that call.

⁦@GlobalVision_UK⁩ ⁦@SteveBakerHW⁩ ⁦@michaelgove⁩ ⁦@DavidGHFrost⁩ ⁦@BorisJohnson⁩ ⁦@johnredwood⁩https://t.co/jQ4ALeDUSB

— Ben Habib (@benhabib6) July 24, 2020Via so-called level playing field terms, the mandate given to Michel Barnier by Europe’s national leaders seeks to constrain the UK’s freedom of movement on subsidies and support for troubled companies via its state aid rules. These partly explain the repeated death, resuscitation and reformation of British Steel. EU rules again prevented the government from rescuing the company in 2019, leading it to fall into the hands of a competitor from China, a country that’s alleged to have reached global dominance in steel through the use of subsidies.

All of Europe’s strategically important steel industry has suffered under the rules, although suffering does partly result from an incompetent if-not illiterate approach to trade defense over the years. Ironically, and importantly, a lot of this resulted partly from actions taken by British Prime Ministers while hidden behind the closed doors of a European Council chamber, including Theresa May and David Cameron. All were ‘EU decisions’ if it suited.

“Boris Johnson is certainly a 'wild card' in all of this. He's extremely tough to read for casual observers like ourselves and certainly for his counterparts in Brussels. So we don't know how much of his 'red lines' in the trade talks are just bluster or how serious he is about telling his negotiators to simply walk away from the discussions at some point. That said, we do think the UK government sees very little political upside to be gained by going for a 'soft Brexit' - given the scale of the economic damage and reset from COVID-19,” Gallo says.

Above: Pound-to-Euro rate shown at daily intervals with 21, 55 and 200-period moving-averages.

Other EU demands seek to influence or constrain freedom of action in a range of other areas too, but would risk rendering the Brexit exercise a largely pointless exercise. Acquiescence might be anathema to some supporters in the broad church of the governing Conservative Party but without some form of agreement, a ‘no deal’ exit from the transition period looms, which might not be welcomed by other parts of the governing party.

This leaves the enigmatic British Prime Minister in a now-familiar bind.

It is axiomatic: if we want a good deal, we must be prepared to leave without one.

⁦@BorisJohnson⁩ and ⁦@michaelgove⁩ must now wholeheartedly prepare for no-deal. And also repudiate the NI Protocol.

⁦@DavidGHFrost⁩ https://t.co/ki3KRokCnk

— Ben Habib (@benhabib6) July 24, 2020Prime Minister Johnson, who has a large majority in the House of Commons, and negotiator David Frost have called out and criticised European manoeuvres in a manner that was previously uncharacteristic of the British side. But Johnson has form for adopting tough stances in negotiations only to fold at the last minute, with another bout of deadlock having given way in October 2019 to a request for an extension of the Article 50 countdown period to EU exit. This was after campaigning for the party leadership on a pledge not to request one.

“The main question is: 'will there be a sharp break-out on the topside or will the pair simply grind higher?' Since we still think a 'skinny FTA' is still possible, we would argue that there is more scope for an orderly grind higher over time,” Gallo says. "We're also working with the assumption that reaching a 'skinny FTA' will yield a modest relief rally in GBP, though we'd probably sell into it."

The Pound-to-Euro rate was down -0.15% at 1.0963 Friday while carrying a -7.14% loss for 2020. It's the third worst performing major British exchange rate for 2020, with only losses to the Krona and Franc being larger.

Above: Pound-to-Euro rate shown at weekly intervals with 21, 55 and 200-period moving-averages.