Brexit: EU Summit may offer GBP some relief

After four and a half years of negotiations and deadlines, compromise and red lines, the Summit’s major focus will be to take stock of the implementation of the withdrawal agreement and review the state of the negotiations on the future EU-UK partnership. Leaders will discuss preparatory work for all scenarios after the end of the transition period on 1 January 2021, with the UK slated to fully exit with or without a trade deal with the EU after this date. The UK left the EU on January 31 this year but has continued to apply EU law without representation at EU institutions.

Stumbling blocks lessen

UK PM Johnson continues to claim that he is ready to walk away from talks with the EU if a deal is not reached in principle by this Thursday. But reports suggest that progress is being made on addressing some of the outstanding areas of disagreement and that the ‘landing zones’ are now in sight – even if both teams still have divergent understandings of what those zones might look like. As chief UK negotiator Frost said recently,” The landing zone and the nature of the agreement is pretty clear if not exactly pinned down yet.”

An agreement over state aid appears to have been struck in principle, although gaps remain over level playing field issues and governance. That leaves the issue of fishing rights as one of the last major obstacles to a deal. The French continue to push a hard-line stance on this emotive problem, aware that they may have to make some concessions, but cognisant that nearly 70% of UK-landed fish is sold in the EU. On the other side, it seems the UK see the stand-off over fishing rights as the tip of their sovereignty concerns and their lever to gain market access to the EU in other areas.

On the way to the ‘tunnel’?

A deal is clearly in both sides’ interests and dangers and accidents always lurk as deadlines get ever closer. However, they most definitely also concentrate minds and even if this week’s deadline is breached and negotiations continue until the end of this month and into November, both sides are likely to claim that some progress has been made. Even incremental improvements in the run-up to the Summit can open the door to a ‘tunnel’ or ‘submarine’ which is where the legal text of a free-trade agreement is hammered out through intensive talks.

Perhaps there may be an issue of trust at stake here after the UK sought to override parts of the previous deal through the Internal Market Bill, so the EU will clearly be reluctant to allow Britain any room for manoeuvre.

Market implications

Given the costs to both the EU and UK of an abrupt exit and the pattern to date of pushing discussions up to the wire and beyond deadlines, the market is ignoring any threats to walk away from negotiations. A narrow trade deal where the UK chooses to align key sectors with EU regulations for a set period will take the risk of an economic shock from a no deal off the table for good and should see cable pop higher towards September’s highs. Net-short positioning still offers some position-squaring upside room as well and so an agreement in principle this week could see EUR/GBP push under 0.90 towards the cycle lows below 0.89.

There may yet be elements of brinkmanship as each side seeks to squeeze as many concessions out of the other as we get near to the finish line. And it’s important to note that the size of GBP shorts is still small compared to other periods where a no-deal outcome appeared as a serious risk. Any hint of an acrimonious no deal will certainly then be a shock at this stage and see sterling tumbling ten per cent.