Deal or No Deal, the Damage Has Already Been Done for the Pound

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Whether Theresa May gets her Brexit agreement or not, the pound's troubles look far from over.

Even as the U.K. government makes a frantic push to secure a pact to ensure an orderly withdrawal from the European Union, another threat is emerging for the currency: Britain's faltering economy. While a deal would reduce immediate uncertainty, much economic damage is already done and any relief rally in sterling could be limited, according to SEB AB. Aberdeen Standard Investments' Luke Hickmore favors maintaining short positions in the pound for now.

The U.K. economy grew at the slowest annual pace in six years last quarter, the latest data show, further dimming the outlook for the currency that has slid 12 percent since the nation voted itself out of the EU in 2016. Fitch Ratings has put the country on a downgrade warning, saying that a no-deal Brexit or a relationship with the bloc that hurts the economy may result in a rating cut.

“We can already see quite clearly that we have a negative impact on the economy,” said Richard Falkenhall, SEB's head of trading strategy. “Even if you get some sort of controlled withdrawal with a deal, the uncertainty will still be there. That's one reason why we don't see sterling rallying enormously.”

Aberdeen Standard money manager Hickmore sees a three-month extension to the Brexit deadline as the most likely prospect, and is worried about negative economic signals including the build-up of industrial inventory, particularly in the automotive business.

‘Structural Damage'

The pound was on track for a weekly gain Friday amid optimism that next week will herald some form of Brexit progress. Though the pound may rally further if a Brexit deal is secured, it will probably top out at around $1.38, according to Hickmore.

While sterling had remained consistently above $1.40 before the Brexit vote, “there has been some structural damage for the U.K. economy we need to get over” before the currency returns to such levels, said Hickmore.

ABN Amro Bank NV has cut its pound forecasts in response to signs of economic weakness and now sees a more cautious advance in the currency on an eventual Brexit deal than it did earlier. It now sees sterling at $1.35 by year-end versus $1.45 previously.

Brexit risk is an increasing drag on the economy, according to ABN. Analysts at the bank including senior currency strategist Georgette Boele pointed to investment “at a standstill” and services-sector data teetering on the verge of contraction as they downgraded their 2019 growth forecast for the U.K. to 1.1 percent.

The downbeat expectations for the economy and interest-rate increases by the Bank of England “combined with prolonged Brexit uncertainty and less U.S. dollar weakness in 2019 means a less bullish outlook for sterling,” said Boele.

To contact the reporter on this story: Charlotte Ryan in London at cryan147@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Anil Varma, Scott Hamilton

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