Britain formally left the EU at the end of January and entered into a transition period, whereby the country is still bound by EU rules, and remains in the single market and is part of the EU customs union. All along, the UK government has insisted that Britain will fully part ways from the EU on December 31, 2020 – with or without a trade deal in place. Back in June, Boris Johnson promised to “put a tiger in the tank”, meaning the negotiations would be sped up and a deal would be sought sooner rather than later. Yet, as of September no deal is in place, and there does not even appear to be the prospect of one on the horizon. Both sets of negotiators have talked down the possibility of an agreement being reached, citing intractable differences, and if time is running out to agree on the big picture elements this leaves little or no time to iron out the nitty gritty legal details.
The main bones of contention revolve around fisheries policy and the EU’s rules on state aid, the so-called level playing field. Neither party can agree on the rules regarding fishing rights in UK waters, nor is Britain willing to agree to EU demands that it follows Brussels’ rules on providing state aid to private companies. EU politicians claim that UK companies would have an unfair advantage over their European rivals if the UK government is permitted to bail them out or provide other forms of aid. However, the UK insists that it must maintain the ability to help out domestic firms if need be. So far, no middle ground has been found on this issue.
So how can we expect the Pound to react as a result of the standoff in negotiations? What would happen if a deal were reached at the last minute? Below we examine some of the different likely scenarios.
The possibility that the UK will leave without a trade deal in place is looking more likely with each passing week. This isn’t mere journalistic speculation; here’s what some of the leading players have been saying about it:
“A Brexit trade deal seems unlikely.” EU chief negotiator Michel Barnier
“EU must prepare for no-deal Brexit.” German chancellor Angela Merkel
“Negotiations are not advancing due to the intransigent and frankly unrealistic attitude of the UK.” French foreign minister Jean-Yves le Drian.
If no agreement can be found and the transition period ends in no-deal, the UK will immediately revert to World Trade Organisation (WTO) rules on trade at midnight on December 31. This would effectively mean that the UK is outside the EU’s single market and must pay tariffs on exports like any other external trading entity.
At present, there is already a Brexit risk premium factored into the value of Sterling. This has seen the Pound under constant pressure since the initial referendum, but a clean break from the EU with no deal would likely see the Pound sink further on Forex markets. How low could it go? There’s no way of telling but without the tether of the EU economy, the UK could face multiple economic problems which would exert considerable downside pressure on the currency.
Although unlikely, if a robust Brexit trade deal is struck there is likely to be considerable upside potential for the Pound. However, full access to the single market would likely be traded for fishing rights and concessions on UK state aid to businesses.
This might be the ideal solution from a currency investor’s perspective, but there are risks. Not least are the political hurdles that would need to be overcome. The UK Conservative Party’s 1922 Committee – a Eurosceptic group that backs full sovereignty – may have the power to cause political chaos for the government and potentially overturn any agreement. If this happens, we could be back to the days of a parliamentary deadlock, with the prospect of political paralysis and even another election.
Markets would not react well to such a situation, and even if the Pound were to get a boost when an agreement was initially made it would likely soon fall back again in the face of political blowback.
At present, a non-comprehensive deal – or ‘fudge’ – could be the most likely outcome if historical precedents are looked at. However, the EU very rarely backs down or gives concessions to individual member states, and it has offered no indication that it would be willing to do so for the UK. As it stands, the EU Withdrawal Agreement is a legal agreement to leave the EU, but some are calling for it to be torn up and replaced with some form of sovereign unilateral agreement. This however would be an uphill struggle and may be politically impossible for Boris Johnson.
Given the current intractable stances of both the UK and the EU, it may be the case that either a watered-down deal is agreed upon, or the Brexit withdrawal period is extended to make allowance for time lost during the Covid-19 crisis.
Either way, out of the three possible scenarios a partial deal is the one that would likely have the least dramatic effect on the value of the Pound.
Observers agree that time is fast running out for any Brexit deal to be reached. As things stand, the most likely eventuality is a no-deal Brexit, meaning the Pound will probably come under intense pressure. Even so, if a deal is struck but it leads to political paralysis, we might expect to see the same effect on the Pound as in a no-deal scenario. On the other hand, if an eleventh-hour solution is found we can expect to see the Pound soar.
There are no easy answers when it comes to forecasting how a currency will behave when so many political wildcards remain in the deck. Nevertheless, if your business relies on steady exchange rates and you want to avoid the risks associated with currency volatility there are things you can do to ensure your bottom line is protected in the event that the Pound either sinks or soars.
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