Brexit uncertainty as we approach trade deal deadline
Investors can expect more volatility in sterling and UK equity markets as the negotiations enter their final stage, says Rowan Dartington’s Guy Stephens.
The negotiated position of the Brexit Withdrawal Agreement, signed earlier this year, has been thrust into sharp focus as we get to the details of the UK’s Free Trade Agreement.
The avoidance of an Irish border for reasons of the Good Friday Peace Agreement always meant we effectively shifted that EU border to the Irish Sea. Here, customs checks and possible tariffs would have to apply between Northern Ireland and the rest of the UK, with Northern Ireland remaining more closely aligned with the EU.
The government seems to have recently concluded that this is an assault on our sovereignty such that our internal trading arrangements between the two UK regions, namely Northern Ireland and the rest of the UK, will continue to be controlled by the EU. They do have a point, but then again, this was the only way to avoid a hard border within the island of Ireland, which everybody knew when the Withdrawal Treaty was agreed.
Separate to this, the trade negotiations over the last few weeks have hit an impasse over fishing rights and state aid.
Firstly, it rankles with many that the EU will not entertain any increase in UK quotas for UK fishermen from UK waters. Prime Minister Johnson is in a difficult position here, even though this is small fry as far as UK GDP goes. He and Michael Gove have always pledged to improve this highly emotional and territorial illustration of UK sovereignty. One view is that the UK should decide and have the ability to change the fishing quotas within its own territorial waters, not the EU, after the transition period has ended. Control of UK waters is considered a fundamental feature of sovereignty and a red line.
Secondly, EU controls over the provision of state aid to industry exists because one member’s government could distort its competitive position by subsidising an industry. The EU is an economic bloc, such that all members compete on the same level playing field and benefit from preferential trade deals negotiated as one bloc, which should be far better than anything a single country could achieve. Of course, it is this belief that many Brexiteers dispute, believing that the UK can do better on its own whilst also restoring its sovereignty and saving a lot of EU subscription money in the process.
Any third country, as the UK will be when the transition period ends, would normally be free to subsidise, tax or incentivise any industry within its borders. Therefore, the argument goes, the UK should also be free to provide state aid to any industry after Brexit, whether that be through direct subsidy or tax reliefs. However, the EU has an issue with this as it sees it as a direct threat to the competitiveness of EU trade if the UK government chooses to enhance its competitive position in certain sectors through state aid. Also, if the EU chooses to impose tariffs on the UK in certain areas to protect EU trade, then the UK could offset that tariff through state aid subsidy and the EU would be powerless to protect its position.
The media is largely reporting on the emotional reaction from Brussels and some members of the UK parliament, the UK’s integrity and the fact that the UK government has admitted that this Internal Trading Bill breaches International Law as laid down by the EU Withdrawal Treaty.
If the Internal Bill is passed then the UK government will have the right to change its trading arrangements with Northern Ireland, which could mean the EU has to create a border between Southern and Northern Ireland to preserve the integrity of the customs union. Without this, there could be a gaping hole for trade arbitrage across the Irish border if the UK removes the customs border in the Irish Sea.
The UK government is most likely taking the view that this is not detrimental to the UK and so not our problem. The EU would therefore be responsible for preserving the integrity of their trading bloc either side of that border and therefore will have to solve the problem without compromising the Good Friday Peace Agreement. Whether this is linked to the lack of compromise with trade negotiations is unknown, but if the EU wishes to avoid this situation then the UK government must be expecting some compromise on fisheries and state aid.
None of this is doing any favours for sterling, which has weakened sharply over the last few weeks as the negotiating impasse over state aid and fishing has become apparent. This trend has increased due to the Internal Trading Bill. Neither side wants to be seen to walk away and be responsible for no-deal but then again, neither side is prepared to compromise at the moment.
If this does culminate in a no-deal Brexit, then we could see yet further weakness seen in sterling and the UK equity market. Some of the uncertainty and impact is priced into markets, and some of the recent weakness has been a reflection of the woeful COVID-19 impact on the UK economy.
For now, however, the markets seem to be assuming that a compromise free trade agreement will emerge and the UK will not impose its own backstop, which is effectively what this Internal Trading Bill puts in place.
Sterling and different areas of the UK equity market are poised to potentially move sharply lower or sharply higher during October – depending who blinks first and by how much.
Guy Stephens is Technical Investment Director at Rowan Dartington, the discretionary fund management and stockbroking arm of St. James’s Place.
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