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Will forex traders’ views on Brexit become reality?

Sterling markets and Europe’s policymakers clearly do not see eye to eye. Analysts say that the positive risks to the currency now outweigh the negatives, while continental European officials say preparations for the UK crashing out of the single market without a deal are under way.

Both parties can’t be right.

Following Theresa May’s resounding parliamentary defeat on January 15 on the proposed divorce agreement, currency investors have priced out the likelihood of a no-deal Brexit and shrugged off the leadership challenge that the prime minister faced just a day later.

As several bank analysts noted, the rejection of Mrs May’s deal has cleared the way for sterling buyers to return to the market as risks have increasingly shifted to the upside for the pound. Derivatives markets are also signalling that big moves in the currency could be on the cards after the March 29 deadline, suggesting an extension to Article 50 or at least that the original deadline is no longer the biggest worry. The chances of a second referendum have also increased, according to banks.

“With . . . Theresa May now holding cross-party talks, the chances have risen of a ‘soft’ Brexit, resulting in the UK retaining closer ties with the EU than her defeated deal would have involved,” said Capital Economics in a note.

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Investors had already trimmed negative bets on the currency going into the week of January 14, according to BNP Paribas’ FX Positioning Analysis, and following the vote these views are likely to have become even more positive.

“We are seeing that positioning is being brought back to neutral, now reflecting . . . a path to a Brexit deal and a possible end to the uncertainty,” said Russell Lascala, co-head of global forex at Deutsche Bank. Eva Szalay

Will Europe’s becalmed volatility gauge stir?

The VStoxx, Europe’s main index for measuring volatility on its equity markets, is remarkably relaxed about the next few weeks.

Its better-known cousin, the Cboe’s Volatility Index, or Vix, which measures the S&P 500’s volatility, has been hovering around 17, below its long-term average of 20 but at higher levels than much of 2018 amid uncertainty over the government shutdown and US-China trade war.

But the VStoxx is even more tranquil about the prospects for Europe’s blue-chips. From a high of 29 just before Christmas it has fallen to 17, nudging its lowest levels since September.

Few analysts or economists expect the region’s markets to rally in coming weeks given that Germany is flirting with recession and Brexit remains as uncertain as ever.

Even so, last week analysts at Bank of America Merrill Lynch urged clients to use the futures market to position themselves “for higher event risk in EU volatility around Brexit and EU election”.

As the ECB meets to discuss interest rates and Britain’s departure from the EU draws closer, that may be enough to inject a spark into the VStoxx. Philip Stafford

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Will the ECB downgrade its economic outlook?

Europe’s central bankers meet this week for the first time since the eurozone’s €2.5tn bond-buying programme ended in December. Although the halting of quantitative easing should imply that the bloc’s economy is improving, a growing number of data indicators suggest cause for concern.

So far the European Central Bank has maintained its position that the economic risks are “broadly balanced”, so investors will be closely listening to its policy announcement on Thursday for any shift in its language. But any overt change in policy is not expected — the deposit rate is at minus 0.4 per cent and the ECB has signalled it will stay there until at least the end of the summer.

“We consider it difficult for the ECB to maintain its balanced assessment,” said Philip Shaw, chief economist at asset manager Investec.

But, in his view, the economic turbulence is temporary.

“We recognise that our forecast of a 0 per cent deposit rate by end-2019 is vulnerable, but our view is that a pick-up in eurozone activity remains more likely than not over the coming months, which suggests that a 20-40bp tightening should remain on the cards this year,” he added. Kate Allen

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