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Brexit returns with a vengeance

The return of Brexit headlines has not been a good development for sterling, as the chance of a ‘no deal’ outcome suddenly rises.

The spectre of Brexit rears its head

We all knew it would come back at some point. Brexit took a welcome holiday from February, pushed out of the limelight by the Covid-19 crisis, something far more important and far more dramatic.

But as the clock ticks down to the end of the year, and the end of the transition period, the issue has exploded back on to the stage. Negotiations have been going on all summer, but without much success, and ongoing frustration with the European Union's (EU's) approach has resulted in UK Prime Minister Boris Johnson taking a new approach.

In short, ‘no deal’ is firmly back on the agenda, and the government is looking at redrafting some legislation in the event that no agreement is reached by the end of the year.

What does this mean for sterling?

For months now the pound has traded against the likes of the euro and the dollar in a manner similar to other currencies. Traders use forex markets to take a view on the economic outlook for a country relative to others, buying or selling as their view shifts. Of course, currencies move in pairs, so a trade on GBP/USD for example is also a means of taking a view on the US economy too.

GBP/USD and EUR/GBP dynamics in focus

The recovery in GBP/USD has been partly driven by the weakness of the US dollar, but also by hopes that the worst of the economic shock is now behind us. While there is still much work to be done, the hope was that the UK economy, like others, would begin to recover, and that it was therefore time to look at GBP/USD in a positive light.

But the return of Brexit changes the dynamic for GBP/USD and others like GBP/EUR too. It is no longer just about the economic outlook, but the political weather too. During the administration of Theresa May, the threat of a ‘no deal’ outcome was never taken particularly seriously; Mrs May was viewed as a proponent of a ‘soft Brexit’ outcome, and was not seen as the type of person prepared to countenance the economic uncertainty of a no deal scenario.

Since the election, the market has taken the view that the government would press forward to a deal, albeit a relatively ‘hard Brexit’ one, that would avoid major economic disruption. The risk of a ‘no deal’ remained, but was viewed as fairly small. Now however the Prime Minister has upped the ante, saying that a ‘no deal’ outcome would be an acceptable outcome. As a result, the pound has fallen.

The details emerging suggest that the state aid rules are a major sticking point, and that Boris Johnson and his aide Dominic Cummings view them as an impediment to helping new technology companies, a key plank of their agenda.

So what happens next?

There is still time to sort a deal, and the much-touted deadline of mid-October is probably a red herring, since mid-November is the more important one. Crucially, if no deal is agreed by then, companies will start to activate their ‘no deal’ contingency planning, reducing the impact of a late deal on any economic fallout.

Negotiations continue, and the potential for another emergency EU summit exists, with hopes that national leaders will step in to help drive the process forward. But the clock is ticking down.

The pound has fallen from its September highs, and given the negative atmosphere at present further losses look likely. Conversely, a breakthrough in talks could see a rebound in the currency, as markets hope for a deal in time for the end of the year.

This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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