Currency traders showed little sign of heightened nerves on Tuesday ahead of Britain's formal launch of negotiations on leaving the European Union. British Prime Minister Theresa May will trigger Article 50 of the EU's Lisbon Treaty with a formal notification of Britain's intent to leave the bloc on Wednesday, kicking off a two-year period of exit talks.
Most analysts said the actual triggering of Article 50 will only have symbolic significance for investors, with the real driver for sterling being how negotiations with the EU will play out, and the health of the British economy going forward. "We don't expect to see anything market moving in the Article 50 letter itself," said Nomura currency strategist Jordan Rochester.
Investors' main fear is that a "hard" Brexit - one in which Britain would lose preferential access with its largest trading partner - would damage the British economy, which is showing signs of faltering. Worries are also growing that Britain's exit negotiations could be tough and protracted, as both Theresa May and European leaders take bold opening stances.
"The market will care whether the exit and new arrangement discussions can take place in parallel, or if the EU sticks to a sequential process with exit talks first and nothing else discussed until they are finished. Given that would lengthen the talks, it is likely to increase that 'cliff edge' pricing," Rochester added, saying that would be negative for sterling. The pound, which has yoyoed in the past month between $1.21 and $1.26 was flat on the day around $1.2553. It was also flat at 86.52 pence per euro. "What many market participants may be underestimating is how difficult the negotiations would be ... because the pound has been doing quite well recently and hasn't been under pressure much," said Thu Lan Nguyen, a currency strategist with Commerzbank in Frankfurt.
Stronger-than-expected UK inflation and signs the Bank of England is edging towards raising interest rates have helped the pound over the past two weeks. It hit a two-month high of $1.2615 on Monday in a move driven chiefly by broader weakness of the dollar. But uncertainty surrounding the terms of Britain's exit from the EU continues to weigh on the currency, still down by nearly 20 percent against the dollar since last June's Brexit vote. Adding to unknowns for investors have been rumblings of another Scottish independence referendum, which threatens a potential break up of the UK just as it departs the EU.
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