Above: David Davis, Michel Barnier (C) European Commission
For the British Pound, expect the Brexit issue to rise in prominence once more as we approach the next set of negotiations.
Ahead of the end-August talks, the UK is seen looking to shift the shape of talks from a staggered goal-orientated timeline to one that sees broader issues discussed in parallel.
We believe such an outcome, if achieved would be good for Sterling, which continues to suffer negative Brexit-inspired sentiment that is looking overdone.
Markets will be watching with interest the EU’s reactions to attempts by the UK negotiate a future trading relationship alongside the EU's stated objective of concluding an agreement on citizen rights, the seperation bill and the Irish border.
Before talks can move on to issues of trade which are essential for Sterling's outlook, Prime Minister Theresa May needs to convince EU leaders at an October summit that enough progress has been made on residency rights, the UK’s exit bill and the border with Ireland
But the UK believes much of the above points can only truly be settled within the context of the final trading deal - something we find to have merit.
What matters for the Pound is whether the stance triggers fresh discord, or a much-needed win for the UK with the latter offering an upside surprise.
Monday has seen the release of further position papers outlining the UK’s negotiating approach to goods on the market and to confidentiality and access to official documents
We note that there has been little market reaction to the publications and this is to be expected. Again - it is the EU reaction that matters so we have to keep watching the newswires for comments.
A Win for the Pound Ahead?
In the week commencing August 14, Britain published its vision for post-Brexit customs arrangements with the EU, seeking to secure “the freest and most frictionless possible” trade even as it acknowledged businesses might face greater red tape.
“Five months after triggering Article 50, the UK government finally produced its first position paper. That was the good news. The bad news was that the proposal for a new customs agreement was greeted with scepticism, as both the content as well as the timing failed to convince,” says Fabrice Montagne, an analyst with Barclays.
Montagne's assessment of the EU reaction is up for debate.
Yes, Guy Verhofstadt’s response was sceptical, but is that a surprise as he is doggedly positioned against the UK?
The official response from the European Commission was actually quite constructive with a mid-week briefing confirming the Commission saw the release of the Brexit papers as a “positive step.”
The contents of the position papers will now be up for debate in upcoming negotiations, but we would point out that the analyst community and currency markets risk being too pessimistic on the British Pound over coming months.
Indeed, the existence of a ‘Brexit bias’ is real as noted by other commentators - Sterling is unloved and even good data from the economy is unable to cheer up the Pound.
But we believe the risks to Pound Sterling are to the upside when it comes to Brexit negotiations because the lion’s share of focus and scrutiny has always been on the UK, however there are two sides in this negotiation.
The EU is rightly the dominant force in negotiations but they might have to concede some ground; and any concessions are likely to be positive for Sterling.
Early evidence of potential for the UK to gain an upper hand is highlighyed by John Foster, CBI's Director of Campaigns, who in reference to the Government's most recent Brexit papers notes:
“The UK Government’s position on goods is a significant improvement upon the EU’s current proposal, whose narrow definition would create a severe cliff-edge hitting consumers on both sides of the Channel.
“Both sides should agree to move talks on to interim arrangements as soon as possible to stem the loss of investment.”
On the broader, more important issue of structuring of the talks and progress, we find the prerequisite of first agreeing the Irish border and settlement fee ahead of talking about trade as being unworkable as surely the border and final fee are a function of the final agreement?
The customs agreement directly impacts the status of the Irish border and future contributions towards the EU budget by the UK are not known. Again, future access could well have a monetary contribution requirement.
This therefore impacts on the final settlement bill.
The EU will surely have to concede that more of the talks will have to run in parallel and relinquish the stepped approach.
But Montagne sees some dangers in the EU being wrong-footed.
“Given the paper presents what appears to be a number of inconsistencies with the EU’s negotiating ‘red lines’, this is likely to increase the potential for delays in the negotiations,” says Montagne.
Nevertheless, sentiment on Brexit negotiations can’t be one-way traffic all of the time and eventually something will have to go the way of the UK.
This is the big risk for FX markets which are heavily biased against Sterling which is already undervalued on many metrics. A betting man might be inclined to take a punt on Sterling as a result.
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Risks of Significant Delays
But we are fully aware that any gains are likely to be limited as a true recovery in Sterling will need the future trading relationship to be nailed down.
And the risks of delays to the process will ultimately cap upside.
“We do not expect the first phase to be wrapped up by October’s EU summit but rather in December at the earliest. The next negotiation round (w/c 28 August), if not cancelled altogether, will most likely formally recognise delays,” says Montagne.
Just how difficult the process will be was highlighted by Solvenia's Prime Minister Miro Cerar who told the Guardian:
"There are so many difficult topics on the table, difficult issues there, that one cannot expect all those issues will be solved according to the schedule made in the first place. What is important now is that the three basic issues are solved in reasonable time."
This is therefore remains the big risk in terms of future downside of a complete stalling of talks amidst EU intransigence.
But ultimately both sides need to press on, as the UK's Department for Exiting the European Union observes:
"The EU exports goods worth €314 billion (around £257 billion) to the UK, more than to Brazil, Russia, India and China combined, which is why it is in no-one’s interest to see disruption and uncertainty."
So these are the big issues to keep an eye on, it should be an interesting Autumn for the UK currency in this regard.
While we see the risk of upside surprises we still maintain that the scope for gains will ultimately be limited.