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Currency Markets Are Making a Dangerous Brexit Bet

Currency Markets Are Making a Dangerous Brexit Bet

Tuesday, 8 September, 2020 - 06:30

Maybe it is a sign of normality finally returning after the pandemic that Brexit is back in the headlines, and that politicians feel they have the license to put it there. But for now, the market is making a dangerous bet that the positioning from UK Prime Minister Boris Johnson doesn’t need to be taken too seriously.

His government is planning to bring legislation this week that would effectively write into British law the negation of much of the deal it reached with the European Union only last year over how Northern Ireland’s border with the Republic of Ireland would be treated after Brexit. It was Johnson’s decision to concede ground on this issue at a meeting with Irish premier Leo Varadkar last October that enabled a negotiated settlement. Without giving way on Northern Ireland, the UK would have left with the dreaded “no-deal.”

Now, no-deal rears its ugly head again. The UK and EU have to negotiate a new trade treaty by the end of this year, to replace the one that held while Britain was a member. Without an agreement, the UK will revert to the baseline terms of the World Trade Organization — which would mean a sharp loss of competitiveness. The EU accounts for a far greater share of the UK’s exports than vice versa, so it appears to have greater negotiating leverage. Yet Johnson is setting Oct. 15 as a deadline to reach a deal, while also apparently promising to rip up the last one.

On the face of it, this is crazy, as my colleague Therese Raphael puts it, not to say breathtakingly reckless, and downright stupid. It might make for tricky internal politics for the UK’s Labor Party, as explained by Paul Waugh of the Huffington Post. The currency market seems to be working on the assumption that Johnson doesn’t mean it. This is a good gesture to give him a little more negotiating strength, and put his increasingly coherent domestic opponents on the back foot — but he surely won’t go through with breaking a treaty he’s only just signed. Such a move would take the UK’s international credibility with it.

That at least seems the best interpretation of a muted response in currency markets. Sterling is down, but has only retraced a small percentage of its strong rally against the dollar and euro. In the following chart, both currencies are indexed to Oct. 9, when Johnson and Varadkar went for their “walk in the woods” and came out with a critical concession on Northern Ireland.

The sharp sell-off to begin the week still leaves sterling slightly above its pre-walk-in-the-woods level against the euro, and still near its highs for the last three years versus the dollar. The pound’s softness against the euro shows that concern has been rising, but it could easily fall much further against both currencies.

That’s because Johnson might actually mean it. A piece by ITV News’s Robert Peston (full disclosure: a boss of mine in a former life) suggests Johnson and his team truly believe that the advantages of a “no-deal” Brexit would outweigh the disadvantages. The critical stumbling block isn’t over trade per se, but rather state aid — how much individual governments can subsidize companies and industries. Such aid can tip the scales of trade competition.

According to Peston, who is known to be close to Johnson’s Svengali-like adviser Dominic Cummings, Downing Street feels differently about that now. The Johnson/Cummings team believes it must have the discretion “to invest without fetter in hi-tech, digital, artificial intelligence and the full gamut of the so-called fourth industrial revolution.” Peston describes the following quote as a Cummings article of faith:

"Countries that were late to industrialization were owned/coerced by those early (to it). "The same will happen to countries without trillion dollar tech companies over the next 20 years."

As far as Cummings and Johnson are concerned, the economic hit from breaking off trade terms with the EU would be a price worth paying.


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