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Brexit and Sterling Roadmap: Political Agreement Likely, but Legal Agreement Could be Months Away

Barnier

EU lead negotiator Michel Barnier believes a deal can still be struck on Wednesday. Image. Lukasz Kobus European Union, 2019. Source: EC - Audiovisual Service

News out of Brussels suggests EU and UK negotiators are stuck over issues concerning the Northern Ireland border question, with the DUP proving resistant to existing proposals.

While both sides are holding out hope that a deal can be agreed on by the end of today, there is a recognition that it would not be a legal deal, but rather a political agreement.

The Times reports Germany believe it will take up to two months to formulate a legal text for a new deal.

This means a political agreement is the best possible outcome from the current talks: this is a commitment to a deal, with the legal documentation finessed over coming days and maybe weeks.

This allows Prime Minister Boris Johnson to offer an indicative vote on a political agreement to MPs, something that would most likely happen on Saturday.

"Johnson could take a political agreement back to Parliament for a vote, saying that a short extension request will be required to tie up loose ends," says Oliver Harvey, Macro Strategist with Deutsche Bank. "A short extension request can be marketed to Brexit voters as a mopping up exercise to provide the necessary time to finalise details as well as to pass implementing legislation in Parliament."

While such an outcome would unlikely set Sterling on a tear higher, it could well secure the currency around current levels.

"There is one important question for the market," says Harvey, "is an agreement at a political or legal level reached in the next 24/48 hours between the UK government and EU27? If so, we would maintain our bullish Sterling and bearish real rates recommendation from last week. If not, we would close these recommendations."

There is a strong chance Johnson could lose an indicative vote on a political agreement in Parliament as many remain-leaning MPs, and of course the main opposition parties, would like to see the Benn Act enacted and a long extension put in place.

"Should Mr Johnson secure a political agreement with the EU27 and lose a vote in Parliament on Saturday, things become more complicated," says Harvey.

How Johnson plays the extension request, as demanded by the Benn Act, will be important. How does he stand by his promise to deliver Brexit by October 31, and at the same time comply with the legalities requested of Parliament?

This offers up a big unknown, and we would imagine Sterling would come under a degree of pressure as uncertainties rise.

Sterling rally on deal chances

Above: Sterling-Euro rallies as a deal becomes more likely, but disappointment invites another trip lower.

At some point the House of Commons would likely agree to a General Election.

However, there are many routes forward for Parliament to pursue, and these include putting a Brexit referendum before any General Election.

They could also take any agreement put before it and make its passing contingent on a referendum.

"Parliament could amend any agreement brought before it to make ratification contingent on a confirmatory referendum. The government has indicated it would not support a referendum, and refuse to finance it. There may be a mechanism by which Parliament could pass the legislation necessary to hold a second referendum even without government support, although will likely prove highly complex," says Harvey.

Deutsche Bank see the majority of Parliament-led scenarios as offering up little risk of a 'no deal' Brexit taking place. They even assume the Conservatives would run in the next election on the basis of the deal template they have struck with Brussels.

This would offer the Pound some downside protection.

However, "one remaining downside risk would be that the election result delivers a strong showing for the Brexit Party, who favour a no deal outcome, such that they would enter into government with the Conservative Party," says Harvey.

Currently the Conservatives are well ahead in the polls with today's YouGov poll putting them at 37%.

However, this improved standing could all be about to change if a deal is rejected by Parliament and further routes forward are opened up.

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