Pound Sterling Under Renewed Pressure as EU Drops an Ultimatum

- GBP sell-off resumes
- Barnier and Frost meet in London

- Expectations of 'no deal' in Brexit talks rise to 50%
- More GBP downside expected by analysts

Brexit clouds outlook for Sterling

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The British Pound fell against the majority of its peers on Thursday as markets ramped up their expectations for a 'no deal' outcome to Brexit trade negotiations after the EU gave the UK an ultimatum to drop plans to pass a law it views as controversial.

The European Commission said on Thursday the EU would give the UK until the end of September to withdraw legislation that it says seeks to undermine the Withdrawal Agreement reached between the two sides in 2019.

If the UK fails to drop the legislation, or retract the offending elements of the legislation, trade negotiations could be called off according to political commentators.

European Commission Vice-President Maroš Šefčovič attended an extraordinary meeting of the EU-UK Joint Committee in London on Thursday to discuss the UK government's draft publication of the “United Kingdom Internal Market Bill”. Following the meeting the Commission said existing clauses in the Bill that relate to Northern Ireland would break "a legal obligation" if passed.

"The EU does not accept the argument that the aim of the draft Bill is to protect the Good Friday (Belfast) Agreement. In fact, it is of the view that it does the opposite," read a statement released by the EU Commission.

Šefčovič requested the UK government to withdraw the offending measures contained in the draft Bill in the shortest time possible "and in any case by the end of the month". If not, "the European Union will not be shy in using" "a number of mechanisms and legal remedies to address violations of the legal obligations contained in the text".

Despite the EU's position, it appears the UK government is not going to budge.

"Parliament is sovereign as a matter of domestic law and can pass legislation which is in breach of the UK’s Treaty obligations. Parliament would not be acting unconstitutionally in enacting such legislation," said the UK Government in a statement. "This ‘dualist’ approach is shared by other, similar legal systems such as Canada, Australia and New Zealand. Under this approach, treaty obligations only become binding to the extent that they are enshrined in domestic legislation."

The developments comes after EU Chief Negotiator Michel Barnier told EU ambassadors he’d seen no progress in trade talks so far this week.

Barnier gave a downbeat assessment of the state of play at a meeting with EU envoys on Wednesday evening, according to a European official quoted by Bloomberg who was briefed on their discussions.

A report by The Telegraph meanwhile says the EU "will start a trade war with Britain if the UK presses ahead with plans to renege on the Withdrawal Agreement and ignores other sanctions possible under the Brexit divorce treaty, according to internal EU documents".

The Telegraph reports the sectors most likely to be targeted by the EU are agriculture and car parts and the City of London would also be likely to lose its access to the EU’s Single Market as part of a raft of sanctions levied against the UK.

The EU is also said to be considering legal action against the UK, which could lead to large fines levied by the European Court of Justice, before the Internal Markets Bill is passed by parliament.

The Pound-to-Euro exchange rate was last seen 1.60% lower at 1.0838 (a good portion of this decline is also a result of the jump in the Euro following the ECB monetary policy event).

Meanwhile the Pound-to-Dollar exchange rate was seen a percent lower at 1.2865. The Pound-to-Australian Dollar exchange rate was 1.88% down at 1.7652.



A Reuters poll of economists shows the expectation for a 'no deal' outcome to Brexit trade negotiations is at 40%, up from 30% in August. The poll was however taken before the UK upped the ante in trade negotiations by unveiling domestic legislation that sought to override elements of the EU Withdrawal Agreement signed last year, suggesting the market's expectation for a 'no deal' event is above 40%.

Indeed, Jordan Rochester, a foreign exchange analyst with Nomura, says the unexpected development means the market's expected probability of a 'no deal' outcome is now more likely set at 50%.

The Internal Markets Bill was introduced to Parliament on Wednesday and seeks to offer "limited and reasonable steps to create a safety net" if current Brexit trade negotiations fail, according to Northern Ireland Secretary Brandon Lewis. The Bill seeks to ensure the unity of the single UK market in the event of a 'no deal' outcome to trade negotiations, thereby ensuring goods can continue to flow unfettered between Northern Ireland and the rest of the UK.

However, it was confirmed by Lewis on Tuesday that the Bill would break an element of international law because it unilaterally overrides the Withdrawal Agreement, leading numerous warnings from EU figures that talks could be placed in jeopardy by the legislation.

"The proposal of the UK to disregard parts of the Withdrawal Agreement is an unprecedented breach of trust of PM Johnson and his government. The validity of our past agreements is a precondition for the negotiations on our future relationship," said Manfred Weber, Chairman of the EPP Group in the EU Parliament on Wednesday.

"The UK’s domestic programme is also creating problems, with Northern Ireland secretary Brandon Lewis admitting in Parliament that proposed new legislation would break international law. Quite how the UK is going agree multiple new trade agreements with partners around the world whilst openly flouting international treaties is a question that GBP is answering in resounding fashion in its decline," says a briefing note from HSBC to clients, released mid-week.

GBP EUR forecast

"If the EU show signs of walking away from negotiations – such as comments the UK Bill is acting in bad faith. Or breaches the WA. Then it becomes nearly everyone’s base case of a no deal Brexit. It would take a lot to bring the EU back to the table if the UK committed to this bill," says Nomura's Rochester.

The growing discord between the EU and UK ramps up political uncertainty which has in turn lead to underperformance by Sterling.

"It’s been just two days of Brexit driving markets again and the move in GBP has been swift. But short GBP still has legs to run; at least until 0.92 in EUR/GBP in our view," adds Rochester.

EUR/GBP at 0.92 gives a Pound-to-Euro exchange rate target of 1.0870.

With regards to the outlook for the Pound-to-Dollar exchange rate, HSBC says they "continue to expect Sterling weakness and see GBP-USD falling to 1.20."

Markets will pay attention to developments over coming days, with the most immediate market event likely to be official briefings from Chief Negotiators Barnier and Frost, likely to be delivered on Thursday.

Expectations are for a downbeat assessment to be delivered and for a breakthrough to only emerge in October when EU leaders next meet.

"The most recent declines in GBP stem from the apparent worsening of Brexit discussions against an increasingly tight timeframe. With neither side showing much willingness to budge right now on the hotly contested topics of state aid and fishing, it will take a meaningful diplomatic breakthrough in the coming weeks to ensure that even some kind of “bare bones” trade deal can be agreed by mid-October," says HSBC.

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