There was little change in the pound to euro and pound to US dollar exchange rates yesterday as both currency pairs closed the day broadly in line with where they opened. Pound to euro has stabilised around 1.1050 struggling to break 1.11 or drop below 1.10, and pound to US dollar has consolidated just below the psychological 1.25 level. Markets were largely driven by an increase in investor’s risk appetite with some currency pairs seeing change but largely the atmosphere was muted. The pound has been weak for some time and whilst Brexit uncertainty remains, it will be difficult for pound to euro and pound to US dollar to return to higher levels.
Whilst the UK and EU have been optimistic in their approach to trade talk negotiations, discussions were ended one day early last week as negotiations concluded Thursday lunchtime. UK and EU negotiators chief negotiators warned that divergences remain, and that little progress had been made, bringing the pound’s rally to a halt.
However, it is understood from sources close to the negotiations that the two sides have begun to draft a “landing zone” which would provide the basis for a Free Trade Agreement. The “landing zone” will involve compromise from both the UK and EU and it is not yet clear how much compromise each will make, but this has proved the pound with some temporary support.
Given the UK and EU’s demands, it is unlikely the FTA will be as comprehensive as some would like but the trade deal will likely eliminate tariffs and quotas on goods. The EU would prefer a more inclusive agreement but due to the “level playing field” demand, the UK is not likely to sign up to this.
This is encouraging for markets but pound to euro and pound to US dollar are likely to remain under pressure as the possibility of “no deal” remains firmly on the table. Whilst, few see more than a 15-20 percent chance of a no deal Brexit, the threat is likely to weigh on the pound until significant progress can be made in trade negotiations.
The pound’s struggle has not been helped by the UK’s decision to not extend the transition period meaning the UK and EU will now only have until October to agree a trade deal as the European Parliament will need time to ratify the FTA. Otherwise, there simply isn’t enough time for an FTA to be signed off before the transition period ends.
What Are the Issues Surrounding Brexit?
There are 3 main areas that the UK and EU are struggling to find compromise on. The first is the EU’s access to UK fishing waters. The EU has insisted that an FTA would only be possible if fishing access was included within the FTA. However, fishing rights are not traditionally part of an FTA and even Norway who operate in the EU’s EEA agree this separately. The UK has flatly refused to compromise here saying the fishing access must be agreed separately and it seems the EU are finally backing down on this demand although the EU will likely see similar access to UK waters. However, it is likely that rights will be reviewed more frequently, perhaps on an annual or bi-annual basis.
The second issue and arguably the most contentious is the EU’s demand for a “level playing field” which would see UK businesses continue to adhere to EU terms. It is difficult to see how the two sides will compromise here but Standard Chartered believe the UK may accept alignment on the current basis but not be compelled to accept new legislation, meaning the UK and EU could divert over time.
The third and final issue is the position of the European Court of Justice. The EU is insistent that the ECJ remains the dispute resolution, something the UK has firmly resisted. Here, the EU need the ECJ to be the overall dispute arbitrator but keep the UK at enough of a distance for the UK to maintain its claim to complete sovereignty.
The UK and EU now appear to appreciate the tight deadline and the political rhetoric from both camps has faded, leaving a more constructive approach to negotiations. If the UK and EU fail to reach an FTA, it could leave them trading on World Trade Organisation terms, which are significantly less attractive than the current Single Market terms they enjoy at present, at a time when COVID-19 is causing unprecedented damage to both economies. Pound to euro and pound to US dollar will be sensitive to Brexit headlines but if the UK and EU agree a trade deal, expect the pound to rally.
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