You could be forgiven for having forgotten that the UK has left the EU, because nothing changed at the end of January, and then the coronavirus came.
Nevertheless, the Brexit story goes on. Brexit anxieties are set to rise ahead of end-June, which is the deadline for the UK to request an extension to the post-Brexit transition period that grants Britain continued frictionless trade with the EU. If there is no extension, the UK could crash out of EU at the end of the year with ‘no deal’, falling far short of original aspirations for an ambitious trade deal.
The UK government appears adamant not to extend the transition period. It would seem that now is not the time for another shock from a no trade-deal Brexit. Asking for an extension of transition would seem sensible until the Covid-19 crisis is over. This could yet be a hardball negotiating tactic to nudge the EU to give ground in the trade talks. However, the hardening of Britain’s position also reflects philosophical differences on how long Britain should be bound by EU rules to ensure fair competition.
The third round of Brexit talks made limited progress. UK and EU negotiators are once again at an impasse over the new trade deal, and neither side appears willing to give much ground at this stage. The list of stumbling block issues remains the same as it has been from the outset of the talks: level playing field commitments, fishing access and governance of the agreement. The next round of UK-EU negotiations begins 1 June, with a European Council meeting scheduled for 18-19 June. A date has yet to be set for a meeting of senior UK-EU officials to “take stock” of progress to date in June.
We believe ‘no deal’ is not inevitable and a ‘limited’ trade deal is still possible in the event the UK refuses to ask for an extension of transition. But difficult negotiations with a looming deadline could be a feature in the second half of 2020, with a messy compromise emerging last minute.
The ride is likely to get more turbulent for GBP again. GBPUSD could fall below 1.20 with the next support close to 1.15. To be clear, the downside risk for GBP would be much larger if a ‘no deal’ outcome becomes the central scenario, in which case GBPUSD could fall below the recent 1.15 low. It therefore makes sense to hedge against downside GBP risks, although the GBP’s cheap valuation should limit the risk of a large depreciation.
The dovish BoE not ruling out negative rates adds another reason to be cautious over GBP prospects. Negative rates is a last resort option for the BoE but the first negative-yielding gilt auction suggests that the market sees a possibility that the double whammy of Brexit woes and the Covid-19 fallout could force the central bank down the negative rates route.Disclaimer applicable to recommendation
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Version: March 2020