Breakthrough on Withdrawal Agreement Aids Sterling Ahead of Key Johnson-von der Leyen Meeting

- GBP bounces on Withdrawal Agreement news
- Johnson to travel to Brussels
- GBP/EUR could fall below 1.0 in 'no deal' says Capital Economics

Above: Prime Minister Boris Johnson talks to President of the European Commission Ursula von der Leyen on Dec. 07. Picture by Andrew Parsons / No 10 Downing Street

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The British Pound extended a short-term recovery against the Euro, Dollar and other major currencies on Tuesday following news that the EU and UK had struck an agreement on the implementation of the Withdrawal Agreement, but nerves are expected to remain heightened ahead of a key call between UK Prime Minister Boris Johnson and head of the EU Commission Ursula von der Leyen.

According to an official statement, agreement in principle has been reached between the EU and UK on the implementation of the Withdrawal Agreement, which was signed in December 2019 following months of intense negotiations and Parliamentary brinkmanship.

The announcement means the controversial clauses in the Internal Market Bill - a bone of contention between the EU and UK - will be dropped.

The Pound jumped on the developments:

The Internal Market Bill and been a source of conflict between the EU and UK as it sought to override parts of the Withdrawal Agreement, thereby effectively breaking an international treaty and souring trust with the EU.

Markets are apparently buying Sterling on the assumption that the development will go some way in rebuilding goodwill between the two sides, and therefore could contribute to the signing of a post-Brexit trade agreement.

"In view of these mutually agreed solutions, the UK will withdraw clauses 44, 45 and 47 of the UK Internal Market Bill, and not introduce any similar provisions in the Taxation Bill," said the statement.

Analysis of joint committee agreement:

So it’s definitely a brexit breakthrough and shows how quickly negative briefing can be rendered redundant

One big hurdle to a trade deal disappeared. But doesn’t automatically mean a deal (in some ways no deal has just become easier).

— Sam Coates Sky (@SamCoatesSky) December 8, 2020

The Pound fell by over a percent on Monday but then began recovering on news Johnson will travel to Brussels to try and secure a post-Brexit trade deal in a face-to-face meeting with von der Leyen.

"GBP has come under renewed pressure this week from increasing no deal Brexit fears. The key event to watch out for is the meeting between PM Boris Johnson and EU Commission President Ursula von der Leyen on Wednesday. We continue to think a deal is more likely than not, which should send EUR/GBP lower again," says Kristoffer Kjær Lomholt, Chief Analyst, FX and Rates Strategy at Danske Bank.

The date of the meeting is however not yet specified and while Wednesday looks to be the obvious day, it could well take place on Friday.

The European Council of EU leaders will meet on Thursday and both Johnson and von der Leyen would be keen to avoid a clash.

The Telegraph reports another option under discussion is a meeting with von der Leyen at the weekend, after the European Council meeting is over, which would give EU leaders the chance to agree a new mandate for the Commission President before she meets Johnson.

Until the meeting we would expect the Pound to remain reactive to rumours but would expect any extreme moves to be faded in the absence of a clear outcome to talks.

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"The view is still that a deal will be reached between the UK and the EU, although confidence levels have certainly dipped of late, but Boris flying to Brussels is a positive development," says a note from the JP Morgan trading desk in London. "We have finally made it to the stage where the political leaders will get more thoroughly involved as Boris in Brussels means he will have access to Merkel and more importantly, Macron. Expect more twists and turns as negotiations spill into the press but we will keep a positive bias and look to fade outsized moves lower in the pound today."

The announcement of a physical meeting was a surprise for markets as it was expected the two would merely try and attempt to make progress over the phone.

The two leaders spoke by phone at 4PM UK time, before Johnson requested the call be paused after about 50 minutes, presumably to converse with advisors.

It was always expected that a breakthrough to the deadlocked talks would only ever be settled at the political level, and it now appears this is the level at which the intensification of negotiations is taking place.

This is a signal that appears to have assuaged market fears that talks would fail in acrimony, with the Pound recovering from losses that were in excess of 1.0% against both the Euro and Dollar at one stage on Monday.

Above: GBP/EUR volatility this week.

The meeting of Johnson and von der Leyen also offers the two leaders that all-important 'photo finish' should they succeed; likewise a pessimist would suggest the move shows Johnson tried his very hardest in the event he opts for a 'no deal'.

Following news of the trip to Brussels the Pound-to-Euro exchange rates has recovered back above 1.10 and is quoted at 1.1018  on Tuesday, while the Pound-to-Dollar exchange rate is back above 1.33 at 1.3347.

"The latest news flow points to an EU-UK free trade agreement being struck just in time for year-end ratification by the EU Parliament. Given markets – and hedge funds specifically – are under-positioned for such an outcome, we would expect a meaningful bounce for GBP on even a ‘skinny deal' outcome," says Arend Kapteyn, Economist at UBS.

But Sterling in 2021 is more than just a bet on a positive Brexit outcome says UBS who note that the currency is positively correlated with the global business cycle - i.e. it rallies when the global economy is in an upswing.

We reported on Monday that economists at Oxford Economics reckon the world will see its strongest rate of economic expansion in 40 years in 2021, and the UK will be amongst the main beneficiaries of this trend.

"This is intuitive given the UK's degree of economic openness, and bodes well for a recovery in global growth into 2021. Naturally, dynamics have changed since the 2016 referendum. But cheap valuations offer hope for at least a partial snap-back in compensation, and the UK stands to benefit more than most in 2021, having being hit particularly hard by the pandemic," says Kapteyn.

UBS are backing the Pound to rise against the Swiss Franc as a key strategic trade for 2021.

But should the EU and UK fail to reach an agreement, the Pound could well fall to below parity against the Euro warn economists at an independent research house.

"There is much more downside risk to the Pound than upside," says Thomas Such, UK Economist at Capital Economics.

Capital Economics forecast the Pound-to-Dollar exchange rate would likely rally to 1.35 in the event of a deal, while the Pound-to-Euro exchange rate could rise to 1.13.

However, in the event of a 'no deal' outcome the Pound-to-Dollar could go down to 1.15 while the Pound-to-Euro could fall to below parity to 0.96.

Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.

A real risk to the outlook for the UK economy and the Pound is in the event of a 'no deal' outcome being an acrimonious one. Capital Economics identify that not only is there a 'deal or 'no deal' outcome to negotiations, but there is a "cooperative no deal" and an "uncooperative no deal".

In a "cooperative" outcome both sides would work together to minimise the negative impact of a 'no deal', while under an "uncooperative" outcome the UK and EU would fall into a series of legal spats and "completely fall" out, according to Pugh.

One of the routes to an "uncooperative" outcome would be via the UK passing legislation that would override elements of the Withdrawal Agreement regarding the Northern Ireland protocol.

The UK government announced on Monday, Dec. 07 that they would eject those elements of the Internal Markets Bill which would break international law and sour relations with the EU if passed, provided a trade deal is agreed.

Therefore, on what the government has said, the offensive clauses will make a comeback if the two sides fail to reach an agreement, suggesting a worst case "uncooperative" no deal would be on the cards.

This would likely drive Sterling to the lower end of the Capital Economics forecasts.