Current Odds For A Hard Brexit Add Risk For Sterling, UK Companies
Investing.com | Jul 05, 2018 05:59AM ET
- Brexit negotiations remain unsettled as final deadline moves closer
- British and multinational companies escalating calls for clarity
- Can UK politicians agree on what they want
- With hard Brexit seemingly baked in, pound may be facing only upside risks
With just a bit more than 200 days until the UK is officially expected to exit the European Union and no real clarity on the details of the final 'divorce,' sterling has taken a beating and businesses on both sides of the divide are escalating their demands for guidance. Uncertainty continues to escalate.
Though it's hoped UK politicians will finally decide what their side wants at a meeting tomorrow, Friday, followed by a presentation on July 9 where details are scheduled to be provided—even assuming that actually happens—negotiators will still need to convince the EU to go along with the proposed deal.
h2 Time Running Out/h2This coming October’s summit was the deadline agreed to by negotiators on both sides for finalizing the specifics in time for the official March 29, 2019 Brexit. If this timeframe were to be met it would leave just 15 weeks for a final deal to be hammered out on schedule. However, despite two years of “negotiations,” the chart below indicates how much still needs to be settled.
It also illustrates how little progress was made during the second quarter. Since March, the UK and EU have only managed to agree on an additional 2,518 words in the Brexit bill. As well, last week’s EU summit, which many hoped would be a critical meeting toward a deal, passed with little to show for it.
The EU’s chief Brexit negotiator Michel Barnier tried to put a somewhat positive spin on the state of play. “On Brexit we have made progress, but huge and serious divergence remains in particular on Ireland and Northern Ireland,” Barnier told reporters. That's not a ringing endorsement of progress. European Council president Donald Tusk was less conciliatory: the "most difficult tasks are still unresolved" and "quick progress" was necessary if an agreement were to be reached by October.
h3 UK Government Divided/h3The major, recent stumbling block hasn't been bipartisan disagreements between the UK and EU. Rather, and perhaps more vexing, the barrier is a division at the heart of Teresa May's government. The UK Prime Minister has yet to get her cabinet to agree on a blueprint for the country's future relationship with the EU. Without this one key factor, discussions with Brussels become impossible.
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“I would like our British friends to make clear their positions,” European Commission president Jean-Claude Juncker said. “We can’t go on with a split cabinet; they have to say what they want.”
To that end, May will meet with her cabinet at Chequers, the Prime Minister's country house, on Friday, in what's been billed as a make-or-break meeting where UK politicians must set aside their differences. May plans for the meeting to produce a so-called “white paper” meant to set out "in more detail what strong partnership the United Kingdom wants to see with the European Union in the future."
May is looking for an agreement to be crafted that would involve staying closely linked to the customs union and single market in terms of goods, though she will likely be unable to include free movement for workers if she hopes to placate hardline Brexiteers.
The Norwegian model, which enables unrestricted trade directly between the Scandinavian market and the EU's single-market European Economic Area (EEA), was shot down by staunch Brexiteers because it necessitated having to accept roughly 20% of EU rules. That option was dismissed by May herself earlier this week. As proposed, this “would not deliver on the vote of the referendum and the vote of the British people,” she told the UK Parliament on Monday.
On Wednesday, May was reportedly prepping a blueprint to keep the UK closely tied to EU rules for trading goods. People familiar with the matter told Bloomberg that the plan for services, which accounts for 80% of the British economy, would be to seek mutual recognition of regulations versus directly following EU rules.
h3 Corporate Call for Action/h3As the clock ticks down and UK politicians continue dithering, companies with ties to either or both the UK and/or the EU have made it clear there's no longer any time to waste. The British Chambers of Commerce (BCC) told politicians on Tuesday to stop “squabbling” and to put the UK’s economic interests first by reaching an agreement on Friday. The organization warned that business patience was “reaching breaking point.”
The BCC perspective: the government had made “limited progress” on only two of the 23 issues urgently needing resolution so firms could plan their trade protocols following the UK’s departure from the EU. The Confederation of British Industry (CBI) and PwC polled 100 firms across the UK financial sector and found that a third of banks said they were "not so confident" of implementing Brexit plans by March.
“Brexit continues to drive uncertainty amongst sector players, from the smaller operators to the market leaders," PwC head of financial services Andrew Kail said. “Location planning, people movements and client retention remain at the top of the agenda, despite the extra time afforded by the transition period.”
The automotive sector has also called for more clarity of what the future might look like for them. “There is growing frustration in global boardrooms at the slow pace of negotiations,” head of the Society of Motor Manufacturers and Traders Mike Hawes warned.
European firms such as Airbus (PA:AIR), Siemens (DE:SIEGn) and BMW (DE:BMWG) have all been vociferous in warning that a hard Brexit would damage their businesses, while a survey of 800 executives by law firm Baker & McKenzie, released two years after the June 2016 referendum, showed that nearly half of the multinational companies in the EU bloc had cut investment in the UK due to uncertainty.
Financial headlines indicating firms are shifting employees out of London to other European hubs such as Paris, Frankfurt, Dublin or Amsterdam have also been increasing.
h3 Sterling Held Hostage/h3That very same lack of clarity has weighed heavily on the pound. FX speculators turned bearish on the currency for the first time in seven months (see chart, above). Indeed, during the second quarter of 2018, sterling showed its worst percentage decline since the Brexit vote.
Cable fell around 5.8% against the greenback this past quarter. That compares to a lesser 5.2% decline in EUR/USD even though, unlike the BoE which recently surprised markets with its slightly more hawkish outlook, the ECB last surprised markets with a dovish decision to put off any rate hikes until at least the summer of 2019. Furthermore, sterling fell about 0.6% against the single currency in the April to June period.
While markets still believe there's a possibility the BoE will hike in August, given the complete uncertainty over the UK’s plan for Brexit, economic worries have taken over the sterling trade. That should come as no surprise. The British central bank has already warned that disruption to financial services could arise from Brexit. In its June 19 Financial Policy Committee meeting, the BoE noted “that progress had been made, but that material risks remained.”
No wonder traders have become reticent about buying sterling. Logic would suggest that both the UK and EU—despite their political battle to insure that each saves face—would prefer to reach some kind of mutually beneficial deal. However, with UK politicians focused on regaining sovereignty by moving out from under the EU’s thumb, while the Union continues to block “cherry-picking” so other members within the bloc don’t feel they’re supporting the costs of the European Union without receiving worthwhile benefits, the path to a mutually beneficial outcome remains murky.
Pushing aside bets for some type of eventual accord, the current status quo clearly points to no deal, which means a hard and likely messy Brexit is in the cards. And judging by the lack of any real progress over the last two years, there's little room for optimism. It's strongly possible that markets have already realized this—sterling's second quarter plunge could be signaling exactly that.
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