Eve Of Article 50 - Buy GBP

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Includes: FXB
by: Max Loh

Summary

Theresa May will trigger Article 50 on Wednesday (29 March) but fears surrounding Brexit are arguably already priced in by the markets.

GBP bears might be blindsided by an increasingly hawkish Bank of England, which might be forced to act on steadily rising inflation in the UK economy.

On the eve of article 50, buy GBP.

Brexit is done and dusted. Theresa May will trigger Article 50 tomorrow, which will officially signal the UK's intent to leave the EU. This on the surface, looks bad for the Sterling Pound. The UK might lose its status as one of the world's leading financial hub, the country might have to pay to exit the EU, Theresa May will have to begin intense negotiations with EU partners to discuss trade details... the number of reasons to sell the GBP are countless.

Except the markets might already have expected all these to happen, way before Theresa May puts pen to paper tomorrow. In short, the series of question marks surrounding the GBP as described above have arguably been priced in by the markets many weeks or months ago, which lends credence to the saying "Buy the Rumor, Sell the Fact".

Recall that it has been approximately 9 months since the nation voted for Brexit. The markets would have more than enough time to ruminate the various outcomes and possibilities post-Brexit. Since the vote in June last year, we have been through a rollercoaster ride of Brexit-related events - with the UK Supreme Court ruling that parliament must vote to trigger Article 50, to Theresa May eventually getting overwhelming support from the MPs to trigger Brexit, to commotion about Scotland wanting to break free of the UK...

Through all that noise, the GBP has traded in a relatively tight range against the USD from 1.20 to 1.27 (about a 6% range) since October 2016. The fall in volatility in the GBP and its range-bound price action tell me that a large part of the uncertainty surrounding Brexit has already been priced in by the markets following the vote.

What the market should be looking out for instead, is rising inflation levels in the UK. As can be seen from the chart below (Source: Office for National Statistics), UK inflation has been rising steadily since mid-2016, courtesy of a weaker GBP. Recall Unilever raising Marmite prices following the Brexit vote, citing weakness in the GBP. Inflation is a growing problem in the UK.

Contrast the robust CPI data with the Bank of England's current interest rate level at 0.25%, a historic low. Low interest rates will fuel inflation pressures, and the Bank of England is debating whether to raise interest rates in the near future.

In its March MPC meeting, the committee was more hawkish than expected, with the votes to keep the benchmark interest rate at 0.25% not unanimous, giving a boost to the GBP that day. Bank of England Deputy Governor Ben Broadbent came out last week to state that the negative effects of inflation on consumers and the economy outweigh its positive effects. As such, there is an increasing amount of buzz surrounding rising inflation in the UK.

On the flipside though, Mark Carney calmed talk on raising rates following February's strong inflation print by warning not to overreact on a single data point, while Bank of England policymaker Gertjan Vlieghe mentioned the current rise in inflation may not be sustainable, and would not prompt him to consider a rate rise.

Regardless, building stealthily underneath the headlines surrounding Brexit are steadily rising price pressures in the UK economy, enough to cause debate within the Bank of England MPC on raising rates. Should more hawkish talk emerge from the Bank of England, this could lend a boost to GBPUSD, and help it over the upper bound of 1.27, a level which is currently restraining the currency pair.

I suspect the markets may be overly bearish GBP given the Brexit headlines dominating the media, but considering Brexit talks and negotiations might last a full 2 years, which is the timeline given to the UK to leave the EU, a more pressing issue that might blindside GBP bears is an increasingly hawkish Bank of England.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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