Pound Sterling Softer on MiFID Headlines, but Broad Dollar Strength Also Pressures the Euro

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– GBP down on MiFID headlines
– EU looks to squeeze UK finance industry post-Brexit
– Naive of markets to think otherwise
– However broad USD strength is day’s big story

City of London

Image © Adobe Stock

– Spot rates at time of writing: GBP/EUR: 1.1805, -0.07% | GBP/USD: 1.2983, -0.09%

– Indicative bank rates for transfers: GBP/EUR: 1.1493-1.1575 | GBP/USD: 1.2629-1.2719

– Indicative money transfer specialist rates: GBP/EUR 1.1650-1.1700 | GBP/USD: 1.2840-1.2866 >> Get a quote

The British Pound came under pressure against the Euro, Dollar and other major currencies in the wake of headlines showing the EU would seek to impose tougher financial regulations on the City of London in upcoming trade negotiations.

EU sources told the Bloomberg newswire that European financial regulators would look to toughen up an existing set of regulations – known as MiFID II – by overturning the concessions they made to the UK.

The move appears to be a clear attempt by the EU to weaken the dominance of the City of London – which is often the generalist term used to describe the UK’s broader financial sector – following Brexit.

“The removal could further complicate UK financial firms’ access, or ability, to do business in Europe,” says Kim Mundy, a foreign exchange strategist with CBA. “GBP/USD is trading back below 1.3000 as moves continue to be dominated by headlines on UK‑EU trade negotiations.”

MiFID was implemented in November 2017 and represented a major shakeup in European financial markets by introducing a series of policies governing research spending, record keeping and trading in stocks, derivatives and commodities. The more stringent policies have been criticised for increasing the difficulty of doing business and imposing significant costs on the financial industry.

The decline in Sterling following the breaking of the news is however most likely not a reaction to news MiFID is to become more stringent, rather it is a reaction to the signal being sent out by the EU: they are willingly going to try and undermine the UK’s financial sector in upcoming negotiations.

Therefore, MiFID is probably just the first battle in a more protracted war.

We would however expect the UK to mitigate any negative impacts of the EU’s moves, most likely by enacting policies that ensure the UK remains an attractive destination for global finance.

Looking at Sterling markets, we can see the currency showed a clear reaction during the period the newswires broke the story:

EUR and GBPUSD

The above shows the move of the Pound-to-Dollar exchange rate, alongside the Euro-Dollar exchange rate (orange line). Note however that Dollar strength does seem to be a culprit in GBP/USD’s move below the key 1.30 support line.

Below shows the movement in the Pound-to-Euro exchange rate which is probably a clearer indicator of genuine Sterling weakness as it strips out the impact of the broader strengthening of the Dollar.

The weakness at the time of the MiFID news is evident but it does suggest the impact is relatively muted:

GBPEUR

While MiFID is a factor behind Sterling’s move lower, it does appear that the strength of the Dollar might in fact be the bigger story of the day.

Indeed, the market’s ability to react to such headlines is again peculiar: the EU is going to attempt to frustrate the UK economy in the post-Brexit era, with financial services being the primary target. We know this and are surprised that the broader market has not priced this.

“Oh look, we have found another justification for smashing the GBP. Pardon me, but I couldn’t care less about this MIFID story,” says Marc-André Fongern, Head of FX Research at MAF Global Forex.

Regardless, the events of the past 24 hours remind us that the tone of the upcoming trade negotiations will be important for how Sterling trades in 2020 and we expect the currency to remain sensitive to headlines such as those involving MiFID regulations.

“In our view, UK‑EU trade negotiations will be the major driver of GBP volatility this year. However, GBP/USD downside is limited because the cross is significantly undervalued relative to the level implied by real two‑year UK‑US swap spreads,” says Mundy.

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Dollar Sweeps Aside the Euro and Pound

The strengthening U.S. Dollar is a central theme for foreign exchange markets in 2020 with the currency recording gains against all its major peers:

Dollar is 2020s best performing major

Above: The U.S. Dollar outperforms its peers in 2020

The U.S. Dollar has been tipped as the preferred safe haven currency during the coronavirus outbreak, largely because the other two major safe havens – the Yen and Swiss Franc – both belong to countries with sizeable trade exposure to China.

Dollar strength is further underpinned by the U.S. economy’s ongoing outperformance of global peers.

“Strong U.S. economic data, coronavirus headlines and a further recovery in U.S. equity markets combined to provide USD support,” says Mundy.

The U.S. ISM non‑manufacturing index rose to 55.5pts in January (55.1pts expected) while the U.S. ADP employment data showed employment expanded by 291,000 in January, almost double the 157,000 expected.

“The strength in the U.S. labour market is one of the key driving forces of the US economy at the moment. Ongoing robust labour market outcomes will be an important shelter for the U.S. economy from any wider implications from the coronavirus outbreak,” says Mundy.

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