Brexit: we’ve been down this road before

Stalemate

After four rounds of negotiations, discussions between the UK and its European counterparts seem to have made little progress. While both parties seek a tariff and quota free trading relationship, there are noteworthy sticking points.

The UK seeks access for financial services, control over its fishing waters and mutual recognition of certain industries and agricultural standards, as well as professional qualifications.

However, the EU is unwilling to provide such access without a commitment to a level playing field, to ensure that the UK does not undercut the bloc in areas such as environmental concerns and workers’ rights. Concerns also remain over the governance of these agreements and cooperation in criminal and judicial matters.

One of the biggest issues which still requires resolving is the Northern Ireland Protocol and avoiding a hard border on the island of Ireland. The UK fears that the arrangement could be an infringement on UK sovereignty and a risk to the integrity of the Union. Meanwhile, the EU is concerned about the integrity of the single market.

What next?

Attention has now shifted to the high level meeting between Boris Johnson, European Commission president Ursula Von der Leyen and EU Council president Charles Michel on 15 June, ahead of the European Council summit on the 18-19 June.

We have all seen the Brexit movie before. While time will tell whether the meeting will lead to a breakthrough in negotiations, we should not be surprised if further discussions are needed well into autumn. Although, in this case, any extension request must formally be put forward before the end of June. Should no request be forthcoming and there is no agreement by the end of 2020, UK imports from the EU will be subjected to the former’s published global tariff terms.

Ripping the band-aid off

Some may argue that the unparalleled hit to output from the pandemic could mean positive growth in 2021, even with no trade deal, given the sharp contraction now expected this year. UK businesses have also had years to prepare for such a scenario. They would finally obtain clarity on the rules of the game, and it would also be in the backdrop of support from policymakers.

The impact cannot be ignored

However, a no-deal outcome would still put significant bureaucratic pressures on businesses, trade frictions at the border (likely to impact supply of essential goods and services) and dramatic cost-push inflationary pressures from sterling depreciation, as a result of tariffs on 60% of EU imports.

Furthermore, a weak sterling may not boost exports given that UK exports have not outperformed since the 2016 Brexit referendum, despite the pound depreciating 15% against the dollar in that time. Not to mention that EU economies would need not comply with UK global tariff terms and could apply higher tariffs on UK exports.

While sterling has benefited from recent risk sentiment, evidenced by its recent rally versus the dollar, the same cannot be said of its performance against the euro, suggesting investor concerns over Brexit and weaker underlying fundamentals. Thus, the coming weeks will be crucial with no extension adding uncertainty and likely weighing on the pound.

Bank of England Governor Andrew Bailey suggesting that financial institutions step-up preparations for a potential no-trade-deal departure illustrates not only how challenging talks have been, but the risks such an exit brings.

Implications for investors

The likelihood of a summer stalemate seems to be increasing, bringing with it continued uncertainty and as a result extra volatility. Although time is tight for a full free trade agreement, both sides would likely be keen to avoid the impact of no resolution. We could see a partial trade deal or even a technical implementation extension. But investors could face a bumpy ride to the somewhat desired destination in coming months.

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