The pound surged more than 1% as the U.K. and European Union announced a Brexit deal has been reached.
Sterling climbed to a five-month high as European Commission President Jean-Claude Juncker said the two sides had reached a fair and balanced agreement. Optimism for an agreement has been building among investors in recent days on a significant change in tone in the talks, though progress had been thrown into doubt early Thursday with the Democratic Unionist Party raising concerns.
U.K. markets have been in the grip of Brexit since 2016 with the pound being the main sentiment barometer - it plunged to its weakest since 1985 in a flash crash in October that year. Sterling has lost 14% since the referendum through Oct. 15, while the FTSE 100 share index has rallied 13% as a weak currency boosts British firms’ overseas earnings. Uncertainty over the split with the EU buoyed demand for the safety of sovereign debt, fueling a gilt rally that almost halved benchmark yields in the past three years.
“The pound can easily trade to levels of around $1.30 if the EU and the U.K. agree on a way forward,” Peter Kinsella, global head of currency strategy at Union Bancaire Privee, said ahead of the news. “Our fair value estimates show pound-dollar should trade at levels of around $1.40. In the short term, the pound’s Brexit-deal windfall will be the removal of investment uncertainty.”
The pound traded 0.9% higher at $1.2942, the highest since May. Traders have been betting on big moves in the currency this week, with a gauge of volatility having surged to the highest since the aftermath of the 2016 Brexit referendum.
European leaders were aiming to get an agreement that could be signed at a summit starting Thursday. The U.K. currency still faces the hurdle of the deal passing through the U.K.’s Parliament in an emergency session slated for Saturday.
That’s not a given as Prime Minister Boris Johnson does not have a majority and lawmakers remain divided on Brexit. His predecessor Theresa May also secured an agreement with Brussels, only to end up resigning after seeing it rejected in the House of Commons three times.
Investors have rushed to cover short positions betting against sterling in the past week as the tone on Brexit changed. Several banks have turned positive on the currency, with Deutsche Bank AG citing the “pivotal moment” last week when the two sides said they could see a path toward a deal.
The weekend sitting by the U.K. Parliament, the first Saturday debate since the Falklands conflict in 1982, will be the next big focus for investors. If a deal does pass, the pound could rally nearly 10% from current levels to the highest since early 2018, according to Mizuho Bank Ltd.
Johnson needs to get Northern Irish lawmakers and hardliners within his own party to support a deal, after previous opposition to anything creating a border between Northern Ireland and the rest of the U.K. Most opposition lawmakers also voted against May’s version, so traders will watching out for reaction to the latest agreement.
“Betting on further volatility still looks like a decent prospect, and better than taking a position in the spot price,” said Stephen Gallo, head of European currencies strategy at the Bank of Montreal.