- Trade talks could break down by April
- Fisheries to be key area of dispute
- GBP to remain sensitive to trade negotiation headlines
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The British Pound firmed at the start of the new week and went back above the 1.18 level against the Euro and 1.29 against the U.S. Dollar. The gains suggest a decent level of support for Sterling but we maintain a view that upside momentum in the currency will likely remain limited amidst growing signs upcoming trade negotiations between the EU and UK will be fraught with difficult.
Reports out this past weekend were that EU-UK trade negotiations could crash "within months", such headlines should feed market anxieties and ultimately ensure the British Pound maintains a soft tone over coming days.
The EU are said to be hardening their demands for unaltered access to UK fishing waters following Brexit, which the UK is vehemently opposed to, raising the prospect for tensions to generate the kind of negative headlines we would expect to weigh on the Pound.
"Today's appreciation of the pound sterling might be nipped in the bud again at any time. The market obviously continues to anticipate a failure of the EU-UK trade negotiations. To my mind, probably a misinterpretation, so I remain cautiously optimistic," says Marc-André Fongern, Head of FX Research at MAF Global Forex.
The Pound started 2020 in strong fashion but has lost ground in February as the focus of currency markets shifts away from the economy and Bank of England policy towards the politics of Brexit.
According to a report in The Telegraph newspaper carried this weekend, European countries are hardening their demands for access to UK fishing waters to remain unchanged after Brexit.
The UK has pledged to take back control of its waters after Brexit which will allow it to determine the amount of fish that can be extracted by EU nations. The UK's sizeable territorial waters are relied upon heavily by Spanish, French, Dutch, Belgian and Irish fishing fleets and it is understandable that these countries see significant negative implications if the UK were to slash their access.
According to the Telegraph report, a fresh draft of the EU's negotiation mandate presented to EU ambassadors over the weekend shows major EU fishing states are looking to instruct chief negotiator Michel Barnier to keep existing fishing rights intact.
According to the newspaper's Europe Editor Peter Foster, fears are growing "that fundamental differences on the shape of the future EU-UK relationship could now crash the talks within months."
We would expect the Pound to remain sensitive to trade negotiation headlines in 2020 and as such see upside in the currency as being relatively limited as all indications are the EU and UK will clash from early on.
"Markets are back to pricing in negatives for Sterling that resemble the 'no-deal' premium we saw weighing on the currency for a large portion of the past two years," says Chris Turner, Global Head of Strategy at ING Bank in London.
The Pound-to-Euro exchange rate has fallen below 1.18 and is now quoted at 1.1773 while the Pound-to-Dollar exchange rate has fallen below 1.30 to trade at 1.2893.
"With the UK-EU trade negotiations starting on a very confrontational tone and the significant amount of concessions that the two parties would have to make to reach an agreement, the prospect of the UK leaving the EU in December 2020 without a free-trade agreement with the bloc does not look too distant," says Turner.
The gulf between the two sides has now left officials in both London and Brussels fearing that talks could break down as early as this April, the Telegraph understands.
Such an outcome, if realised, could have a notable negative impact on the value of Sterling.
"The currency will remain vulnerable to further downside bets on the back of jittery sentiment when it comes to the UK-EU future trade relationships," says Turner.
The first major area of dispute is likely to be the structure of the talks. Look for the EU to propose a staggered approach whereby certain items have to be agreed before talks can progress to their final conclusion.
Recall this was a big win for the EU in the Brexit negotiations which began in 2017: the EU demanded the exit agreement be agreed before trade negotiations could commence.
The UK will be alert to any such pitfalls, this therefore could be where talks get initially bogged down.
Another major area of contention is likely to be broader structure of the trade deal, which is something that must be agreed from early on.
The EU are reportedly seeking that the entire future relationship, which includes trade, security and other agreements like fishing rights, are bundled into one agreement.
EU sources told the Telegraph that the package would allow for a "cross-cutting" dispute mechanism whereby if there is a dispute in one area, the EU can hit the UK with sanctions in another.
In short, the fear in the EU is that the UK will look to diverge in some areas where it has an advantage and this bundled structure allows them to hit back in another area where the UK proves more sensitive.
The UK understandably does not like this idea and would rather each area of negotiation is packaged into a water-tight agreement, with a corresponding dispute mechanism.
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