Sterling drops as European Union warns just hours left for Brexit deal

Sterling fell on Friday, reversing some of its recent gains, after European Union chief negotiator Michel Barnier warned that there were just hours left to reach a Brexit trade deal with London.

The British currency is still on track for its best week since the end of July as market confidence has risen sharply this week on hopes that the European Union and Britain will clinch a last-minute trade deal ahead of a Dec. 31 deadline, when a Brexit transition period ends.

Almost a year after Britain formally left the EU, the two sides are in the final stretch of talks over a post-Brexit trade deal.

The pound hit 2-1/2 year highs above $1.36 this week, but Friday’s trading session served as a reminder that the two sides still have divergent ideas on how they want to build their future relationship.

Barnier told the European parliament that the path to an agreement was “very narrow”, while British Prime Minister Boris Johnson said the British door was open but that the EU should see sense and compromise.

“The latest comments are creating a little bit of doubt in markets, but most still see a deal as highly likely,” said Adrian Schmidt, head of FX strategy at Continuum Economics.

Schmidt added that the latest comments from Johnson looked like “an attempt to wring concessions out of the other side at the last minute”.

Sterling weakened to as low as $1.3489 and was at $1.3505 by 1334 GMT, down 0.6% on the day. Against the euro, sterling was down 0.4% at 90.71 pence .

“The pound corrected from its 2-year highs in early trading today but remains at levels that clearly signal a lingering optimism on a deal and GBP downside risk remains asymmetrically higher in case of no-deal,” ING analysts wrote in a note to clients, adding that a deal could still be agreed over the weekend.

U.S. investment bank JPMorgan said the probability of a trade deal had risen to 70% from 60%.

Meantime, Bank of England policymaker Gertjan Vlieghe said the central bank may need to cut interest rates below zero for the economy to fully recover, according to Bloomberg TV.

Britain’s Prime Minister Boris Johnson on Friday acknowledged continuing issues with Brexit trade talks but vowed to plough on, as the EU said a “moment of truth” was approaching.

“Our door is open. We will keep talking but I have to say that things are looking difficult and there’s a gap that needs to be bridged,” he said on a trip to Bolton, in northwest England.

“We have done a lot to try and help, and we hope that our EU friends will see sense and come to the table with something themselves.”

Portugal’s foreign minister said on Friday he believed a trade deal between Britain and the European Union was still possible and said a close relationship between both sides was essential.

“I think it (a deal) is possible,” Augusto Santos Silva said during an online event to discuss priorities of Portugal’s European Council presidency, which kicks off in January.

“If not, we have to trade according to World Trade Organisation rules but we cannot renounce a close relationship between Britain and EU,” he added.

The Bank of England may need to ramp up its stimulus programme including a possible cut in interest rates below zero for the economy to recover fully from its coronavirus slump, policymaker Gertjan Vlieghe said, according to Bloomberg.

Vlieghe has previously said he sees few risks that negative interest rates would be counterproductive.

But other BoE officials are more doubtful and there was no mention of the topic in the minutes of the BoE’s most recent policy meeting published on Thursday when the central bank kept its key lending rate at 0.1%.

“Once we talk about adding significant stimulus to the economy, then the rate cut we can do without going negative is obviously very small,” Vlieghe told Bloomberg in an interview on Friday.

“The risk it ends up being counterproductive is low, and therefore if we find ourselves in circumstances where we need more stimulus, that would be a risk I’m willing to take.”

Sterling and British government bond yields fell after the comments were published.

Vlieghe said the coronavirus hit to investment and jobs and Brexit - “whether there is a deal or not” - might mean an economic recovery peters out earlier than hoped

If markets are calm but demand is weak enough to justify more stimulus, a combination of more asset purchases and probably lower rates would be needed, he said, echoing recent comments by fellow policymaker Michael Saunders.

Meanwhile, US investment bank JPMorgan said the probability of a brexit trade deal had risen to 70% from 60%.

“Our sense is that the likelihood of a deal has moved up from the 60-40 we had as the week began, and we now mark that up to 70-30,” JPMorgan analyst Malcolm Barr said in a note to clients.

“In our view, solutions to all of the issues listed above which both sides would be able to live can be designed, even if the process of getting to them is difficult.”