May 19, 2020 / 8:21 AM / 17 days ago

Brexit risks and talk of negative rates limit the pound's recovery

LONDON (Reuters) - The pound was up 0.5% against the dollar on Tuesday, holding on to gains from overnight trading, and rose versus the euro - a small recovery relative to its recent seven-week lows.

FILE PHOTO: British five pound banknotes are seen in this picture illustration taken November 14, 2017. REUTERS/Benoit Tessier/Illustration

Positive signs from a coronavirus antibody trial saw safe-haven currencies such as the dollar fall as markets rallied. But analysts said the pound did not fully join this relief rally, as it remains held down by Brexit-related risks and some speculation about negative rates.

The pound’s overnight strengthening was small compared with its recent downward trajectory. It is the worst performing G10 currency so far this month.

“Apart from all the corona problems, concerns about Brexit have arisen again,” said Thu Lan Nguyen, FX strategist at Commerzbank.

“I think this will lead to continued underperformance of the pound in the next couple of weeks certainly, up until the EU Summit,” she said.

Officials from both sides say that little progress has been made in Brexit negotiations.

Britain set out plans for a post-Brexit tariff system on Tuesday.

The pound had hit a seven-week low against the euro on Monday at 89.60 pence, but strengthened to as much as 89.19 pence at around 0630 GMT. It weakened during the day before starting to strengthen around 1220 GMT and was last at 89.325, up around 0.2% since New York’s close.

Against the dollar, the pound had slipped below $1.21 on Monday. It hit a low of $1.2185 around 0320 GMT on Tuesday before recovering to as much as $1.2268 in early London trading. It was last at $1.2247.

Goldman Sachs analysts wrote in a note to clients that implied volatility and risk reversal pointed to more downside risks.

“GBP implied volatility has lagged during the large reset lower of FX volatility and it is now at a premium vs the EUR and JPY (but still lower than in 2016 and 2019 in absolute terms),” they said.

Sterling-dollar implied volatility gauges with a one-month maturity edged down slightly on Tuesday, still holding near three-week highs.

NEGATIVE RATES?

The market has started to price in the possibility of negative interest rates.

A Bank of England rate-setter, Silvana Tenreyro, said on Monday that the central bank has not ruled out negative interest rates.

This added to speculation after the bank’s chief economist, Andy Haldane, said negative rates were being looked at more urgently.

But many analysts think the bank is unlikely to bring in negative rates and is more likely to add to its quantitative easing programme.

Commerzbank’s Nguyen said that if the bank introduced negative rates by a 25 basis points cut, the effect on the pound would be limited, whereas a cutting cycle would have more impact.

Reporting by Elizabeth Howcroft; Editing by Larry King, Giles Elgood and Alex Richardson

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