Sterling gains on optimism over Brexit, second best week of 2018

The pound enjoyed its best day of the year on Thursday as a market heavily short the currency rushed to adjust to the possibility that a Brexit deal will be clinched in the coming weeks.

Sterling gained on Friday, putting it on course for its second best week of 2018 on optimism for a Brexit deal and signals from the Bank of England that if the exit from the European Union is smooth more interest rate hikes could be on the way.

The pound enjoyed its best day of the year on Thursday as a market heavily short the currency rushed to adjust to the possibility that a Brexit deal will be clinched in the coming weeks - removing a major uncertainty overshadowing the economy and the BoE as it tries to bring inflation back to target.

"Were it not for Brexit uncertainty, the Bank of England would probably have laid the groundwork today for its next rate hike," BNP Paribas analysts said in a note.

"Once the MPC (Monetary Policy Committee) gets the Brexit 'green light', we expect two hikes in 2019, in May and November – sooner, and by more, than markets expect."

Money markets are not fully pricing in a full 25 basis point rate hike from current levels of 0.75 per cent next year, however, underscoring investors' worries about whether a disorderly Brexit can be avoided.

Sterling rose 0.3 per cent to $1.3037, its highest since Oct. 23. It slipped 0.1 per cent against the euro but remained near two-week highs after Thursday's huge jump.

David Madden, an analyst at CMC Markets, said that if the pound held above $1.30 "it could pave the way for $1.3250 to be tested", but if sterling drops again the currency may fall towards $1.2661.

The British government and EU officials have played down hopes for an imminent Brexit deal, emphasising that while an agreement is close the two sides still have work to do.

Any agreement with Brussels would then need to win approval from British parliamentarians before the Brexit date of March 29, a far from easy process given factions with Prime Minister Theresa May's Conservative party oppose her plans.