BNY Mellon: Today In Brussels

7 feb 2019

As noted yesterday, the recent declines seen in realized volatility in many GBP crosses have simply brought these measures back towards their 10-year moving averages.

In other words, GBP crosses appear to be behaving normally at present. This stands in marked contrast to many other currency pairs that are experiencing significantly lower than average volatility at present. This matters when thinking about today.

As also noted, realized volatility for many GBP crosses has been trending broadly higher since Parliament returned from its recess last summer. This is consistent with a pattern noted on a number of occasions in The Aerial View that realized volatility in GBP tends to be at its lowest during periods of Parliamentary recess and rises as the political tempo picks up.

The evidence from this week would certainly seem to support the idea that politics (and specifically Brexit) remains the prime driver. The real question therefore is which part of the story is catching the markets attention.

Since the start of the week, there have been two main periods of GBP-related market volatility. The first (a modest GBP decline) was during the European morning on Monday and coincided with fresh comments from Ireland’s finance ministry saying that the Irish government would not take part in bilateral talks with the UK on border technology.

The second (and rather more substantial) move came on Tuesday, emerging on the back of weaker than expected services PMI data. It's noticeable, however, that the move lower intensified at around 14:00 GMT. While no Brexit-specific headlines emerged around this time, details of Tuesday’s lobby briefing (mainly focused on the UK government’s negotiating position going into Thursday) were made public within about 30 minutes of the move.

During the briefing the UK prime minister’s spokesperson implied that Theresa May would have new proposals to put to the EU for the backstop when she went to Brussels today.

Three ideas are reportedly being considered. Two involve ensuring the UK could not be kept in the backstop, either by imposing a time limit, or by creating a mechanism that would enable the UK to leave unilaterally.

The third would involve replacing the backstop with an alternative customs arrangement that would avoid a hard border in Ireland.  

While it might be an obvious point, this does help clarify that the outcome from today’s negotiations could provide the key generator of volatility for GBP this week.

Given this, it’s also worth noting the equally obvious point that while there has been plenty of discussion of what might or might not be going on behind the scenes in Brussels, what has actually been said so far doesn’t particularly suggest that a major shift is likely.