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October 23, 2018

Europe in choppy water amid Brexit and Crisis in Italy

All the talk at last week’s EU summit in Brussels was around the topic of Brexit. Specifically, the news was about a lack of news, as Theresa May remained at loggerheads with her European Union counterparts over the terms of Britain’s withdrawal from the EU. May addressed the EU Summit for 15 minutes, during which time she discussed Britain’s progress in Brexit preparations and requested a special summit to be convened next month. The other leaders, however, saw no reason to agree, and feel that negotiations need to make more progress before there is any value in such a meeting.

The “no deal, no news” is a further embarrassment for May’s government, but the implications go far beyond politics. Brexit is going to have a significant impact on businesses, investors and everyday people across the European Union and beyond. But while the impact on importers and exporters, and the importance of a deal relating to customs duties has already been discussed at length, there is another area in which Brexit will be felt equally strongly. The Forex market is certain to be dramatically affected, and traders are already preparing themselves for some dramatic events on March 29 2019.

Traders hate uncertainty

As soon as headlines containing the word “Brexit” start appearing on newspapers, the value of the pound starts to drop. It fell like a stone following the referendum, when the world was faced with the stunning news that the British people had voted to leave the EU, and while it was one of the best-performing currencies at the beginning of this year, it only needed the word “no deal Brexit” to enter the world’s vocabulary for it to hit a five-month low by the end of May.

Slight recovery over recent months has once again stalled in the wake of this latest show of uncertainty coming out of Brussels. The message could not be plainer – the market, the traders and the ECN Forex brokers that guide their decision making do not like uncertainty, and while the current impasse remains in place, sterling will continue to fall in all the major currency pairs.

What is ahead for sterling?

The trading community is, therefore bracing itself for a brutal time ahead as far as the pound is concerned. Will there be another plummet of the kind seen in June 2016 when March rolls around? It is a possibility, but by no means a certainty, and it all depends on that same word – the uncertainty factor. Next March is going to be different to June 2016 in one key way, in as much as we know that Brexit is coming. The more we know about the terms of Britain’s departure, the lower the impact is likely to be on the Forex market.

In fact, if Theresa May is able to successfully negotiate a trade deal with the EU that works for all concerned, there is every chance that the pound will start to pick up over the rest of 2018 and early 2019. One thing is certain, and that is that the pound is going to continue to show considerable volatility in the months ahead.

The bigger picture for Europe

There is still a vocal core of “remainers” in the UK who cannot quite believe that Brexit is really going to happen. However, it is not just the pound that is looking shaky as a result of the negotiations and the lack of progress. There are two sides to every divorce, and the Eurozone is also feeling the pinch.

The Euro might not risk destabilization to the same effect as sterling, but it will still feel the effect of Brexit. And the current uncertainty could not come at a worse time for the European Union, with the dispute over the Italian budget still raging.

The key thing that Forex traders and investors need to keep an eye on here is, again, nothing to do with party politics. The budget dispute, and the general feelings of disquiet since the Italian election, have combined to have a major impact on the spread between Italian and German government bonds.

This spread has climbed steadily over recent months, and if it continues to do so, the Euro will start to weaken sooner or later. Some are going so far as to predict a destabilizing effect that could do lasting damage to the single currency. While this seems more a matter for concern for those very long-term investors, even day traders need to keep a watching brief on events in Brussels and Rome as they continue to play out.

However these two stories end, it is fair to assume that both the Euro and sterling have some challenging months ahead, particularly if the dollar maintains its current strength.

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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