Room for pound to strengthen

Although the EU has agreed to extend the deadline for Brexit to 31 January 2020, a no-deal Brexit cannot be written off completely yet. The threat of a no-deal Brexit would reemerge if the withdrawal agreement fails to pass by the end of January. It all depends on the outcome of the 12 December UK general election. The pound stands to gain in the event of a deal and its smooth implementation. It should reach around 1.35 on an immediate note against the USD, while the ringgit should fall to about 5.65 against the pound. Thereafter, the pound should climb to around 1.40–45 against the USD while the ringgit is expected to weaken to around 5.80. During this period, the focus will shift from politics to economic data.

A. What the UK election means

• Brexit will not take place on 31 October after all. The new deadline is 31 January 2020. Does that mean that a no-deal Brexit is off the table? The answer is no – it is not completely off the table.

• If the UK does not pass the withdrawal agreement by the end of January, the threat of a no-deal Brexit would reemerge. It all hinges on the outcome of the 12 December UK election:

• Scenario 1: If Boris Johnson returns with a majority, he could get the deal quickly passed. The MPs have until 31 January, 2020 to sort it out;

• Scenario 2: A hung parliament or a split between different views of what should happen on Brexit would raise uncertainties. This will also raise the uncertainty of Brexit happening earlier than 31 January.

• Could the withdrawal agreement be reopened after the election? At the moment, the EU says no. But who knows?

• If the UK leaves with a deal, it will be less material to Ireland. However, in an event of a no-deal Brexit, Ireland will see World Trade Organisation tariffs come into play and this will affect trade between Britain and Ireland as well as threaten jobs in the food sector in particular, and other sectors reliant on the UK market. It will raise the prices of UK imports in Ireland. British-Irish trade will be similarly affected on a no-deal Brexit.

B. Foresee a stronger pound

• The pound has become overweight from underweight and so have most of the pound assets with the fear of a no-deal Brexit receding. Thus, the pound is likely to see a “floor” with the EU granting a “flextension”.

• The strength of the pound will depend more on the outcome of the general election and/or the Brexit implementation and in particular, how the new trade relationship between the UK and Europe, and the UK with the rest of the world will look in reality.

• A deal should see the UK economy improve. That should see Bank of England (BoE) shift its stance to a more hawkish tone, thus favouring higher interest rates. Higher rates would support the pound as there will be more inflows of foreign capital. It will be positive for the local currency.

• However, even if there is an agreement on an exit deal, it will be the beginning of a lengthy process around negotiating future trade relationships with the EU and the rest of the world. Thus, the level of uncertainty will remain and the pound should see a U-shaped rebound and not a V-shaped one.

• In the event that a deal is agreed and implemented smoothly, the pound should reach around 1.35 on an immediate note against the USD, while the ringgit should fall to about 5.65 against the pound. Thereafter, the pound should climb to around 1.40–45 against the USD while the ringgit is expected to weaken to around 5.80. During this period, the focus will shift from politics to economic data.

C. Business perspective

• On the business perspective, at the moment, British companies will continue to trade with Malaysia. Likewise, Malaysian companies will continue to trade and invest in the UK. But without any clarity of a deal or no-deal, it is difficult for Malaysian investors to plan in the immediate term be it in the UK's real estate or manufacturing sector.

• Also, the uncertain environment puts a lid on the UK which cannot negotiate any free trade agreements on its own as long as it is still part of the 28-member EU bloc. Nonetheless, in anticipation of a Brexit materializing, we should remain open to what the UK government has to say. A deal will bring about more positive prospects for investments by both UK companies and Malaysia companies while the focus remains on how the final relationship between the UK and Euro will look like.

Source: AmInvest Research - 30 Oct 2019