Sterling strengthens after U.K's new trade deal with E.U.

The U.K. sterling gained on Monday after the country formed a new trade agreement with the European Union, which analysts said signaled improved relations between Britain and the eurozone.

The sterling strengthened against the U.S. dollar by one percent to peak at $1.2069. The euro also gained 0.05 percent to $1.0614 after rising 0.6 percent in the previous session.

Britain and the E.U.'s new deal, the Windsor Framework, covers trading arrangements for Northern Ireland. British PM Rishi Sunak said the agreement would open a new chapter in London's relationship with the E.U.

The Windsor Framework is designed to replace the Northern Ireland Protocol, which came into force in January 2021. The Northern Island is subjected to rigorous inspections for goods sent from the U.K., whether the goods will remain in the region or be transported to the E.U. This checking system creates a clear border between Northern Ireland and the rest of the U.K., but at the same time incurs extra costs and causes delays.

Sunak explained that the new framework would reduce the number of checks required for these goods by separating items that will stay on the Northern Island and those that will be passed to the E.U.

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"We're introducing a new Stormont Brake," Sunak said. "The elected Assembly can pull the brake for changes to E.U. goods rules that would have significant and lasting effects on everyday lives.

"When pulled, the U.K. government will have a veto. This gives Northern Ireland a powerful safeguard."

The agreement needs to pass through the British parliament, but the opposition Labor Party already said it would vote in favor of the deal. Meanwhile, Northern Ireland's Democratic Unionist Party leader Jeffrey Donaldson said the party was still sorting through the details of the agreement.

"The mood music suggests that this thing will succeed … there probably is scope for some sort of residual sterling strength here."

Ray Attrill, Head of F.X. Strategy at National Australia Bank

Ray Attrill, head of F.X. strategy at National Australia Bank, predicted that the deal would most likely pass through. Attrill explained that the sterling might further strengthen in the coming days, thanks to the agreement. The strategist said the deal was especially critical as it could lead to stronger partnerships between London and Brussels.

E.U. Commission President Ursula von der Leyen had earlier said the E.U. would reinstate the U.K. into the Horizon Europe scientific program as soon as the new agreement goes into effect. Analysts said the deal could remove the prospect of a trade war and attract more investors to the U.K.

U.S. dollar rallies

The U.S. dollar index, DXY, was flat early in the session but eventually rallied. The greenback is on track to post a 2.5 percent gain this month, breaking its four-month losing streak.

The U.S. dollar also steadied against the Japanese yen at 136.23. The Bank of Japan is currently in preparation for the change of leadership. Its incoming governor, Kazuo Ueda, has not provided details on how the BoJ can exit its massive economic stimulus.

The New Zealand dollar weakened slightly against the greenback, falling by 0.02 percent to $0.6165. On the other hand, the Australian dollar gained by 0.13 percent to $0.6748. It rallied following the sharp increase in Australia's current account surplus in Q4 2022.

Analysts expect the U.S. dollar to continue its rally in the coming days as the market predicts that the Federal Reserve will further increase its benchmark interest rates. The federal funds rate is projected to peak at around 5.4 percent this year.

Although the market previously predicted that interest rate cuts would start this year, analysts now say the Fed will likely only begin cutting its rates next year.

Attrill said the dollar index would move according to new major inflation indicators, adding that in the coming days, the greenback would be influenced by inflation data for February.