Brexit Woes Hit the Pound as the Market Braces for another Rollercoaster Year for the Pound

With Britain now officially out of the EU, there’s no going back for Boris Johnson and the Tories.

In late 2019, we saw the Pound briefly visit $1.33 levels as the markets responded to Johnson’s landslide General Election victory.

The victory had brought hope of an end to the political wrangling in Parliament and a more aggressive stance with the EU.

Not only did the British PM reunite a divided Tory Party but he also managed to renegotiate with an EU that had been previously unwilling to budge on a previously agreed Withdrawal Bill.

Johnson pushed through his Bill, supported by the sizeable majority in Parliament. The British PM also ensured that there could be no extensions to Britain’s transition period.

While the Withdrawal Bill raises the chances of a hard Brexit, it also removes the option to drag negotiations out. The last thing the British PM wanted was a repeat of the Brexit negotiations that ultimately led to a series of Brexit extensions.

So, with less than 11-months remaining until Britain’s ‘set in stone’ end to the transition period, trade negotiations are the market’s area of focus…

 

The Trade Agreement

 

There are a number of trade agreements that the EU has with non-EU countries. Switzerland and Norway, Canada and Australia are ones that have been the area of focus in recent years, albeit for different reasons…

As far as Boris Johnson and the Brexiteers are concerned, however, it’s a free trade agreement that is Holy Grail. An agreement, however, that comes without strings attached… Such an agreement would mirror the existing agreement between the EU and Canada.

The chatter has already begun, however, with Britain having only entered the transition period on Saturday.

Comments from the EU’s chief negotiator Michel Barnier raised yet more alarm bells. Similar to those that the markets had experienced over the last 3 odd years.

Barnier stated on Monday that, while a highly ambitious trade deal was on offer, Britain would need to agree to the EU’s rules…

Unsurprisingly, the British PM responded by saying that Britain would prosper even without a trade agreement with the EU.

If there had been hopes of smooth sailing into the sunset, Monday’s comments are likely to be a taste of things to come. Over the near-term at least.

We saw the Pound slide back to sub-$1.30 levels in response to the comments from both sides. The last thing that the markets want is for trade terms between the UK and the EU to fall under WTO terms.

To be fair, it is also unlikely that the EU and Britain want WTO tariffs either, but there is one issue.

Boris Johnson will never agree to follow EU rules and the EU is unlikely to give in to Britain’s demands… Not all of them at least.

Brexit isn’t Brexit if the UK continues to be beholden to the EU after the transition period. For the EU, giving into Britain’s demands would give other EU member states reason to consider going it alone.

It’s not just about Britain, for the EU it is also about keeping the Union united.

What’s next?

 

Boris Johnson’s Holy Grail is a trade agreement similar to the free trade agreement that Canada enjoys with the EU.

While the Pound took its first blow on Monday, there’s a long way to go.

And, with the EU and Britain at polar opposites on what is wanted, there will be plenty of sparring in the early part of the transition period.

After all, it wouldn’t be politics without it…

The problem for the Pound, the UK economy and even the British PM is that the muscle-flexing will lead to more uncertainty.

At the end of last year, the Tories were more than optimistic in negotiating a no strings attached trade agreement.

Going into February, there will be no agreement at all if strings are attached.

Some will argue that Britain’s clear intent is positive. It also suggests, however, that WTO tariffs could become an eventuality.

For the Pound

We’ve been here before and that should mean limited upside for the Pound near-term.

With the EU unlikely to concede to Britain’s demands any time soon and Johnson primarily interested in a complete break from the EU, both sides are on for a head-on collision.

The more negative chatter there is, the worse it will likely be for the Pound. Even with the market’s experience of the last 3-years.

After Johnson’s December General Election victory, there had been the hope of a return to $1.35 levels. It now looks more likely for the Pound to visit sub-$1.20 than bounce back and eye $1.40 levels.

The three scenarios for Britain, the Pound, and Brexit are therefore

A Canadian style free trade agreement, an Australian style trade agreement that is largely in line with the WTO rules but with some side agreements and worst-case scenario, a fall back to WTO rules.

Then there is the question of whether Britain will be truly free. Or will Johnson have to agree to some strings attached in the event of an agreement?

For the Pound, however, the latter is likely to be of less of an issue. Though politically it would be another story if Johnson agrees to strings attached…

We saw Theresa May’s political career come undone over the failure to deliver Brexit. Johnson could fall onto the same sword if he fails to deliver a promised free trade agreement. One that has no strings attached. Party unity would certainly be tested should the British PM begin to make concessions early in the process…

So, a rollercoaster ride it is and negotiations aren’t even due to start until March…. It could get even more interesting if U.S President Trump gets involved…

At the time of writing, the Pound was up by 0.11% to $1.30037.