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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 70% of retail investor accounts lose money when trading CFDs with this provider.
You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

A Brexit deal is likely but could just be a matter of time

Although the UK formally left the EU at the start of 2020, a trade deal has yet to be agreed. We are currently in a 12 month post-Brexit “transition period” in which the two sides are looking to agree a trade deal. However, the clock is ticking and the end of the transition period is nearing. Despite this, there have been positive signs on a prospective agreement in recent weeks. There will be significant implications for sterling from whether or not a trade deal can be agreed.

 

The backdrop

The UK and EU are still locked in negotiations over a trade deal that would shape their future relationship in the post-Brexit era. If no agreement has been formally signed by 1st January 2021, the UK will come to the end of its transition period and leave the EU with no agreement on the shape of their trade relations. The UK and EU will then revert to trading on World Trading Organization (WTO) rules.

An agreement is needed to avoid significant tariffs and red tape impacting on businesses. It is therefore broadly agreed by most people (aside from perhaps the most ardent of Eurosceptic people) that a trade deal is in the interests of both sides.

 

Progress being made, but not enough, yet

A soft deadline of the October EU Summit came and went with no agreement. However, in late October negotiators felt that enough common ground for agreement was present that would persuade the sides to step up talks into a phase of intense negotiations. Importantly, the talks have not yet entered the “tunnel” stage (the final and crucial stage) but hopes are that this can be seen soon.

 

What’s holding up an agreement

There are three significant stumbling blocks to an agreement.

  • Fishing rights – the UK wants to restrict the amount of access that EU fishing fleets has to UK waters and their plentiful fishing stocks.
  • Competition rules – the so called “level playing field”. The EU wants the UK to play fair and engage in a convergence of standards and practices for businesses. EU Chief Negotiator Michel Barnier said that they needed to make sure that future common standards should “evolve over time”. This is something that the UK is vehemently against. They will not agree to anything that ties the UK to the EU’s standards.
  • Furthermore there is yet to be an agreement on the mechanism for resolving disputes. However, in a potentially key development, Barnier has agreed to keep separate police and judicial co-operation from any potential futures sanctions over trading disagreements. This is an important concession that could certainly oil the cogs towards an agreement.

 

The Biden factor

The recent US Presidential election adds an interesting factor into the mix. US President elect Joe Biden has previously been very critical of Brexit. His Irish ancestry means that he has a keen interest in maintaining peace between the UK and Ireland. His fear has been that Brexit (and specifically a hard Brexit) would threaten the Good Friday Agreement (a peace deal that ended decades of political a religious violence) and potentially lead to a hard border between the UK and Ireland. This could result in huge consequences for peace and stability as it would likely inflame tensions between the two countries. He has also warned that this could be a potential deal breaker for any UK/US trade deal.

Part of the attraction of Brexit is the ability to make trade deals, but if this is put at jeopardy then would it impact on the negotiations? This could push the UK Government towards making a deal with the EU to prevent trouble further down the line with Biden’s US administration.

 

What next?

It has been suggested now that the EU leaders summit on 19th November in a final deadline for a draft Brexit trade deal. Moving beyond that date, the logistics of ratifying the political agreement across the EU institutions and in the UK Parliament become very difficult to administer before the start of 2021. However, we were also told previously that the EU Summit on 15th/16th October was a deadline. So this would suggest that EU deadlines are not always what they appear to be.

According to the EU’s Barnier, there is still agreement to be found, so hope is still there.

 

An agreement is likely

We believe that with the Biden factor there is added incentive in driving the UK into agreement. The EU would also prefer not to have a chaotic relationship with the UK, one of its biggest trading partners.

History also tells us that the EU loves to leave it late with deals and agreements. We believe it to be interests of both sides to have a trade deal, so we believe that a deal will be reached. It may just be a question of “if” but “when”. This could be the key sticking point for the impact on GBP in the coming weeks.

 

The impact on GBP

With talks seemingly progressing in the right direction for a deal, markets have been pricing for improved expectation of a deal. For sterling this comes in the shape of GBP strengthening. An orderly EU/UK trade deal would be positive for GBP (and also EUR for that matter).

We expect volatility to increase around the EU Summit on 19th November. However, if this deadline is missed, we will see selling pressure on GBP, probably for at least a few days as markets come to terms with the disappointment. However, our base case scenario remains that a deal will be reached.

As long as an agreement is achieved (which we see is likely) then we would prefer GBP to outperform, especially into 2021. As for EUR, we would also expect some buying pressure (against USD) on the relief of an agreement, but the upside would be less significant than that for GBP.

However, the big risk would now be for no deal. If there is no deal agreed, it would likely push the Bank of England into ever looser monetary policy, perhaps into using negative rates. This would hit GBP hard. EUR would also suffer in this scenario as it would be a hit to Eurozone economic outlook (although less so than on the UK). There would also be a negative impact on broad market risk appetite.

Looking at GBP currency pairs, there are two scenarios to really consider for the rest of 2021: Deal or no deal.

  • GBP/USD – Deal agreed would drive Cable through $1.35 to levels not seen since early 2018. GBP could rally towards $1.40. However, if the two sides do not agree a deal, this would likely drive Cable into the low $1.20s.

  • EUR/GBP – A deal would pull Euro/Sterling into the mid to low £0.80s into 2021. The alternative no deal scenario would see the cross into the mid £0.90s and perhaps surpass the COVID spike high of £0.9500

 

Richard Perry

Richard Perry

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