Brexit and the pound – are we at breaking point?

We were always going to get here; the fact that the Article 50 period ended following last December’s election always made 2020 a crucial year for Brexit. This gave the UK one year within which to formulate the outlines of a trading deal with the EU or we leave without a trade deal and therefore trade with the EU on WTO terms. It is worth remembering what a No-Deal Brexit would most likely look like.

Tariffs are what most think about when they think of a no-deal Brexit; costs will increase for both UK importers (and hence consumers) and exporters. The average EU tariff rate is low – around 1.5%. However, at a sectoral level, the impacts would be much larger: for example, for cars and car parts the tariff rate is 10% and therefore could make the UK manufacturing sector no longer viable for integrated EU supply chains.

Similarly, a move to cut all tariffs to zero would endanger the UK’s agricultural sector that has long relied on EU subsidies and would be exposed to global agribusinesses that would put additional margin pressure on UK farms.

For the services sector – the main engine of UK growth, it’s non-tariff barriers that remain the greatest risk from a no-deal Brexit; travel restrictions, the red tape of EU access and employment shifting to the EU to ensure regulatory approval.

We must also remember that Brexit was originally founded on the basis that the UK would be able to diverge from EU regulations. Over time, if there is divergence between UK and EU standards, UK businesses would need to produce two different product lines which would increase costs and reduce competitiveness.

From an economics point of view, we have to expect that trade, investment and productivity falls will make the average Brit poorer with the UK business sector seeing both a fall in access and output subsequently.

No transition, six months to go

Time is ticking however, with the EU and UK both accepting that the transition period that ends in December will not be extended. Subsequently, the UK is now saying that it needs the outline of a trading deal by the Autumn otherwise it will need any remaining time to prepare the UK and its wider business community for a no-deal Brexit.

A recent addendum to the Terms of Reference on the UK-EU Future Relationship Negotiations has outlined the next round of talks, with meetings taking place every week through July before a break at the beginning of August.

These trade talks will dominate the outlook for sterling in the coming months with the impact increasing the closer we get to the end of the year. History dictates from previous points of Brexit stress that those with sterling exposure should be wary of how the pound trades on Fridays and Mondays. Friday is typically when a week of talks will end and we will hear from both the UK and EU as to how well that week’s conversation has gone. Monday trade is typically affected by the political revelations of the Sunday papers with politicians typically going ‘on manoeuvres’ to make sure their viewpoint is heard.

 What can businesses do?

It’s worth remembering what businesses can do to protect themselves against the issues of Brexit – be it an exit that ends with a deal or without.

If you haven’t already it makes sense for companies to consider the short, medium and long term impact of Brexit on your business as well as the risks caused by supply chain disruption; a full audit of supply chains will likely reveal both risks and opportunities.

We’re big fans of communications at Equals and we think this is an important time for businesses to be open with EU based suppliers and where appropriate, begin planning joint strategies to mitigate risks.

We also think it important that British businesses keep showing support and appreciation of EU suppliers as anti-British sentiment in mainland Europe could increase your risks and mark you out as someone with whom it has become difficult to trade with.

Part of this step up of communications should include a review of contractual arrangements with EU-based suppliers so as to consider re-negotiating terms such as contract duration and break clauses.

The three main risks that we foresee over the next six months for businesses that operate internationally, or form part of an integrated supply chain are:

  • Supply chain elongation – logistics delays limiting damaging a company’s market positioning
  • Unnecessary price inflation – having to become uncompetitive due to needless price increases
  • Currency risk – not protecting vital margins by speculating on movements in currency markets

How will authorities react?

Both the UK government and the Bank of England have reacted positively to the threat of Coronavirus but it is the latter who has done the majority of the heavy lifting for the UK economy since the UK voted to leave the European Union back in 2016. Moving forward we expect that relationship to continue.

A conversation that the Bank of England has become part of in light of the extraordinary level of monetary support that central banks are offering economies though the current crisis is the possible taking of interest rates into negative territory.

We think that is unlikely for now, but something that markets are looking for towards the end of the year i.e. come crunch time on the UK’s future relationship with the European Union. This, alongside forecasted increases in the level of quantitative easing, will likely act as a depressant of sterling in the coming months.

From government, we expect a Budget from the Chancellor in the coming months, mainly in a bid to restore economic productivity following lockdown. Separating Brexit from that is currently almost impossible, but a wider look at fiscal issues – the kind threatened by an exit from the EU without a deal – would likely emerge once that die has been cast.

The outlook for sterling

While we do not believe that we are breaking point just yet, the triple whammy of Brexit uncertainty, a rocky return from lockdown and the possibility of negative interest rates, are significant blockers to sterling strength moving forward.

Our monitoring of options markets suggest that the wider sentiment of market participants is negative on the pound the further out you look, both before and after the end of the year and the subsequent conclusion of this phase of Brexit.

To help protect your business against the travails of Brexit and the uncertainty that Covid-19 provides for sterling, get in touch with our team of expert dealers at Equals FX on 020 7778 9365 or visit equalsfx.com

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Jeremy Thomson-Cook

Jeremy Thomson-Cook

Jeremy has over 13 years experience working in the FX industry. As a specialist in political risk mitigation and currency hedging, he regularly advises clients on the day-to-day moves of the markets and the implications of fiscal and monetary policy on international businesses.