Brexit: get ready for a volatile six months
Brexit is coming back into play after taking a back seat to the coronavirus crisis. We have a look at what to expect as negotiations reach a pivotal point over the next six months.
Brexit had been the key driver of markets since the UK voted to leave the European Union (EU) in 2016. But a much bigger problem in the form of the coronavirus has swept Brexit aside, and the timing couldn’t have been worse.
The current state suggests Brexit will come firmly back into play in the coming months, and the threat of a hard no-deal Brexit at the end of the year has returned. It is highly likely that the coronavirus will still be causing huge disruption for businesses at the end of this year unless a vaccine or treatment is found, and now they face having to deal with the possibility of a no-deal Brexit too.
Will there be an extension to the transition period?
The UK formally left the EU on 31 January 2020, and entered a transition period whilst the pair discuss the future trade relationship. The UK no longer has a seat at the EU’s table, but it is still part of the single market and has to abide by other rules, like the free movement of people, until the transition period ends.
The transition period will end at the close of 2020 unless the pair agree to extend it. Technically, it could be extended for one or even two years – but an extension must be agreed before the end of June 2020, according to the Withdrawal Agreement signed by the pair. That means, if one is not agreed by then, that the transition period will end at the start of 2021 and trade between the UK and the EU will have to fall back on either a new trade deal or onto World Trade Organisation (WTO) rules, otherwise referred to as a no-deal Brexit.
The EU has been much more open to the idea of extending the transition period than the UK, where there is almost no appetite among the government. As far as the UK is concerned, an extension would simply prolong the uncertainty for businesses at a time when it needs to, more than ever, be in control of its own destiny. An extension looks less likely than ever despite calls that the divorce should be delayed because of the chaos being caused by coronavirus, and any change of heart would represent a huge U-turn for the UK government.
Interestingly, there is a debate over whether the transition period could be extended past the 30 June deadline. Although it could get messy and legally complicated, it is not impossible that an extension could be agreed later this year. Some have argued the Withdrawal Agreement would simply have to be amended to scrap the 30 June deadline, but others say this would be difficult.
Will the UK and EU agree a Brexit deal?
The current scenario adds to the pressure for the pair to strike a new trade deal that can come into force at the start of 2021, in order to avoid a no-deal Brexit whereby trade would be hampered by tariffs and checks.
However, the EU has consistently stressed that a deal would need to be agreed before the end of October in order for it to have enough time to get it ratified by all members. That means the UK and the EU have just over four months to hash something out.
Right now, the pair look no closer to a deal than they did at the start of the year. There are major sticking points and neither side looks open to budging at present. The situation hasn’t been helped by the fact negotiations have been forced online to get around lockdown measures. The UK’s chief Brexit negotiator, David Frost, recently said talks with the EU were ‘close to reaching the limits of what we can achieve through the format of remote formal rounds’.
However, there is hope of some momentum being injected as the clock runs down. Prime minister Boris Johnson is expected to announce talks will be held more regularly in July, with the two sides to meet weekly rather than every three weeks.
Interestingly, this isn’t the first time the UK has mounted a late effort to get a result. The last deal struck between the two looked very unlikely until one was unveiled at the last minute, and there is still every chance that the UK and the EU will find common ground as the threat of a disruptive separation gets closer to becoming a reality – especially if coronavirus is still around. But the UK is sticking to the line that it intends to embark on its own future from the start of next year with or without a deal with the EU.
What are the sticking points to agreeing a Brexit deal?
Little headway seems to have been made this year and the UK and the EU remain at odds over a number of issues. The first is how the UK maintains free-flowing trade with the bloc without compromising the EU’s rules. The EU wants the UK to abide by certain rules to ensure its ‘level playing field’ is maintained, like on state aid and environmental laws, to ensure it doesn’t get to trade with the bloc whilst also gaining a competitive edge. The UK wants to trade with the EU but is reluctant to be hamstrung by the EU by giving up certain aspects of sovereignty and independence.
The second matter ties into that. The pair are reported to have clashed over how any future relationship between the two sides will be governed and how any disputes will be handled. The UK Institute for Government has said there are two choices, but it seems the pair can’t agree on what avenue to go down. The first is using an existing institution, like the European Court of Justice (ECJ), but that is highly unlikely as the UK would argue the EU is in charge and that it undermines the position of UK courts, or the WTO’s dispute settlement system. The second is to create a new institution, either from scratch or based on an existing one, although both will undoubtedly disagree over the details of any new organisation that would play such a major role for decades to come.
The third is fishing, which has been a huge and contentious issue throughout the entire Brexit saga. Existing EU arrangements means fishing quotas are divided up among member states, giving rights to countries to fish in other’s waters. The EU is keen to retain access to British waters for European fishermen as part of any trade deal but the UK – obviously in a powerful position as an island – believes fishing rights should be negotiated separately and regularly reviewed.
Does coronavirus provide a cover for no-deal Brexit?
There is a strong argument that the coronavirus crisis and the huge economic ramifications it will have should encourage both parties to compromise or delay Brexit as businesses will have enough on their plate later this year. However, there is also one that the chaos caused by the coronavirus could mean it’s an opportune time for the UK to make a messy break from the EU.
Economies have collapsed, global growth forecasts have been downgraded and recessions are on the horizon. Globalisation and international trade are being questioned, and international travel will be healing from the scars for years. This, some argue, could provide cover to mask the consequences of a no-deal Brexit at the end of this year – any issues could be blamed on coronavirus. However, it could also be the perfect time for the UK to react to the permanent changes that the coronavirus will have on the way the world works.
Having said that, the UK government is aware of the double whammy that businesses potentially face at the end of the year if there is a no-deal Brexit and the coronavirus to contend with. It has announced that it no longer intends to introduce full border checks on goods flowing in from the EU at the start of 2021 under a no-deal scenario to try and ease the pressure, but insists this would be a temporary measure to respond to the coronavirus pandemic and that its long-term plan of implementing full checks is still intact. The EU will decide how to handle UK goods entering the bloc and the UK will be hoping the bloc will reciprocate the gesture to maximise its effectiveness.
How to trade Brexit volatility in 2020: watch GBP/EUR
Coronavirus has meant financial markets have experienced higher than normal levels of volatility this year, and the pandemic will remain a key driver for the foreseeable future. However, the spotlight will return to Brexit as markets track the key moments for negotiations this year. One of the most exposed assets to the Brexit talks is GBP/EUR, and you can expect this currency pair to see increased volatility from late June onwards.
The general attitude of GBP/EUR has been to strengthen when a Brexit deal looks more likely and when the markets think disruption will be minimised; and weaken when talks breakdown and a no-deal Brexit comes back into play.
The first date to keep in mind is 30 June, the last date that the UK can technically ask for the transition period to be extended. Markets are likely to react favourably, and the pound would likely rise if an extension was agreed as it would delay any disruption later this year, even if it prolongs the overall uncertainty. On the other hand, if no extension is agreed by this date then the pound could weaken as it raises the stakes and puts a firm deadline in place.
If no extension is agreed as anticipated, then the UK and the EU will only have a few months to strike a deal, with the EU adamant one has to be in place by the end of October. If a breakthrough is to be made then it should happen before this date, which is likely to support sterling, but if negotiations have failed to make headway as that deadline looms, then no-deal becomes more likely and the pound is likely to weaken as a result. If no agreement is in place by late October then no-deal will become the most likely outcome, unless the pair throw up a surprise late in the year. However, it is extremely important to remember that Brexit will not be the only thing impacting financial markets and the pound, with the coronavirus likely to remain the overriding issue in 2020. For example, a breakthrough in negotiations could be overshadowed by a spike in coronavirus cases, or a breakdown in talks could be overlooked if progress is made in containing the virus.
This information has been prepared by IG, a trading name of IG Markets Limited. 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. See full non-independent research disclaimer and quarterly summary.
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