Comment: As Brexit talks begin where will pound end up?
By market analyst Neil Wilson
As the first official Brexit talks getting underway on Monday morning, there are several possible scenarios for the pound based on where these talks take us.
The talks kick the week off in fairly dramatic fashion with the UK and EU officially beginning negotiations on the divorce.
The big question is what alimony is due, who gets to keep the house and car, and where the kids should live. It’s not you it’s me, Britain is saying. The EU will take its perfidious partner back any time, although with stricter rules. The trust is gone. Some think it’s better off without an unreliable spouse anyway.
So it’s in this acrimonious environment that the process begins and that is going to make it tough going for investors looking for clues about whether we get a soft or hard Brexit, something that is between the two, or no Brexit. It would be easier for Britain if it knew what it wanted in the first place.
A CLASSICS LESSON
It is a modern-day Melian dialogue. Britain, as Melos, faces an unpalatable choice: die free or live as slaves. Go it alone in the hope of a free trade deal or seek to live in the single market or customs union – adhering to Athenian rules but not setting them.
Rather like the Melians, it looks as though Britain’s chief points are more concerned about what it hopes ‘may happen in the future’, while its resources are ‘too scanty’ to tackle the forces ranged against it.
Britain too has agreed to the talks proceeding along the lines laid down by the larger party. And like Athens, the EU has no reason to be generous to these ‘unsubdued’ islanders whose recklessness endangers its empire.
The EU is likewise worried about ‘subjects who have already become embittered’ by the constraints which the EU imposes on them. An example must be made.
CONFUSED NEGOTIATING POSITION
Where do we start with this? Ostensibly nothing has altered since May's Lancaster House speech in January – the UK is aiming for a smooth and hard Brexit.
But of course since the election everything has altered.
Phillip Hammond has emerged from his election campaign hibernation to start talking up the importance of getting a deal that is good for jobs and economy.
For this, read a softer Brexit that puts immigration way down the agenda. Even then he is still for leaving the single market and customs union. The picture is confused.
How do you negotiate when you don’t know your own position? It seems bizarre to press on before the government is secure in its ability to command a Commons majority and before the Queen’s Speech, but the UK has to show willing – the dithering has to stop.
NO DEAL? NO WAY
May has said "no deal is better than a bad deal". The EU doesn’t buy this, nor do most MPs. As a starting point for a game of poker it’s not a bad position, but it’s also perhaps a touch unrealistic given the economic and legal problems that would ensue from a cliff-edge exit. This no-deal outcome is being priced out – it’s less likely now following the election as Mrs May’s hardball stance is coming unstuck.
However we still have the prospect of no deal if talks don’t go well. Britain says it will approach the talks in good faith. A lot hinges on how it goes this week. The EU wants to secure cash and rights for citizens immediately and is not willing to mess around. For Britain to get a good trade deal it might have to acquiesce or talks could turn sour.
A smooth deal is also looking harder. Parliament is split and Mrs May cannot even command a majority without DUP support. Even then her MPs are not all on side and it would take only a few rebels to block. While the EU is speaking with one voice, Britain is a chorus of competing voices.
VERY SOFT, ULTRA-HARD OR IN BETWEEN?
Is a soft Brexit even possible? Donald Tusk says not – the only alternative to a hard Brexit is no Brexit, he argues. Mrs May is pressing on with the hard option. The EU won’t allow cherry-picking and is blocking Britain from speaking directly to member states.
Very soft Brexit: A Norway-style deal will not be acceptable to Brexiters. In essence it would be like Britain remaining in the EU without actually having a say in how it’s run. Such a scenario, which would protect single market access and therefore be ‘market-friendly’, is going to be unpalatable to the 52% and easy to argue against. It would undoubtedly be positive for sterling and could see GBPUSD regain levels seen before the referendum, but looks highly unlikely at present. It would represent a major shift in the government negotiating position for this to be on the table – a new government perhaps? Domestic political uncertainty means this scenario remains a possibility, however.
Softish Brexit: On a par with Turkey. Remaining in the customs union could be an option that both sides can just about stomach. It would be reasonably market friendly and likely help the pound to rally towards the $1.40 mark. It seems to be one of the more likely soft Brexit options, although currently the government does not wish to pursue this fox as Britain would not be able to strike its own trade deals with other nations – a blow for the hard Brexiters’ ‘global Britain’ agenda.
Hard Brexit: The Canadian model. Exit single market and customs union and hope for a free trade deal. This is one that Mrs May’s Conservatives are currently aiming at but carries a large degree of risk. As the larger partner, the EU holds the trump cards. The pound would gain some support above the $1.25 level but a lot would depend on the scale of any deal.
Ultra-hard Brexit: Complete and abrupt exit from the EU with no trade deal and on WTO terms. The cliff-edge scenario is low in probability but potentially catastrophic for UK businesses. Tariffs would appear overnight. Economic growth would stall, potentially leading to recession and a steep sell-off in the pound towards $1.10.
Neil Wilson is senior market analyst at ETX Capital