LONDON: The pound rose on Monday but lagged behind other risk-linked currencies, as investors focused on talks over post-Brexit trade arrangements for Northern Ireland as well as the likelihood of the Bank of England raising rates next month.
Relations between Britain and the European Union have deteriorated in recent weeks after Britain, unhappy with the Brexit deal it signed up to in 2020, threatened to trigger an emergency clause known as Article 16 of the Northern Ireland Protocol, potentially leading to a trade war.
But the European Commission's Maros Sefcovic said that he is "absolutely convinced" that Britain and the European Union can break their impasse. At 1605 GMT, the pound was up 0.1% against the dollar at $1.34265, up from the 11-month low of $1.3354 it hit on Friday last week.
Versus the euro, it was up around 0.3% at 85.04 pence per euro. Analysts were split over how much impact the Brexit tensions were having on the pound. "The FX market has still been quite reluctant to price in any Brexit-related risk premium on GBP," wrote ING strategists in a note to clients.
"Our moderately bullish bias on GBP for the remainder of the year is tied to the view that markets will continue to steer away from embedding much political risk into GBP."
Weekly CFTC positioning data showed that speculators are overall bullish on the pound versus the dollar. But one-month risk reversals - a gauge of the market's expectations of the pound's direction - hit their lowest since December 2020 on Thursday last week. The gauge is in negative territory which indicates the market expects the pound to fall.
"The ever-falling level of the risk reversals suggests that the market is getting increasingly worried about the pound, which I suspect has something to do with the UK brinksmanship around Article 16," Marshall Gittler, head of investment research at BDSwiss Group, said in a client note.
Neil Jones, head of FX sales at Mizuho, said that the Brexit tensions were "a continuing headwind for sterling" but that until there is clear event such as triggering Article 16, the move will be a "gentle slow grind lower... as opposed to a sharp move."
In the week ahead, markets will be focused on the UK jobs report on Tuesday and CPI data on Wednesday. The Bank of England will be the first major central bank to raise interest rates but whether that initial increase comes as soon as next month or early next year has divided economists polled by Reuters.
BoE Governor Andrew Bailey said he was very uneasy about the inflation outlook and that his vote to keep interest rates on hold earlier this month, which shocked financial markets, had been a very close call.
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