Brexit Article 50

Sterling risks surrounding Article 50 fade, uncertainty still a major factor

Prime Minister May’s Brexit speech on January 17th clarified the UK negotiating stance. The clear commitment to pulling out of the single market has removed an important downside Sterling risk surrounding the triggering of Article 50 which is planned for late March. There will still be a high degree of uncertainty and there could be further delays with risks associated with a tough EU stance also a significant factor. Overall, the performance of the UK economy is likely to be the pivotal factor for Sterling.

Prime Minister May removes uncertainty

During the fourth quarter of 2016, there was continued speculation and uncertainty whether the government would look for a ‘hard’ Brexit which would put the UK outside the single market or whether it would look for a ‘soft’ Brexit with the UK looking to remain inside the single market.

Attempting to stay inside the single market would require complex negotiations and, crucially, it would have been highly unlikely that the other EU members would allow single-market access without the UK accepting freedom of movement. Controlling immigration was, however, a key objective of the government which made continued single-market access very problematic.

In general, a ‘hard’ Brexit was seen as negative for Sterling while a ‘soft’ exit was seen as more positive for the currency. Primarily, this was due to expectations of more substantial short-term damage to the economy if the UK left the single market. In this context, there were particular fears that the financial services sector would be damaged with the potential for banks and financial-services companies to relocate away from London.

May’s speech has certainly clarified the situation as she announced that the UK will leave the single market once it leaves the EU. She also confirmed that the UK would not look to use an existing model such as Norway or Switzerland in formulating a deal and would look for a unique arrangement.

This clear commitment will remove an important downside risk associated with the actual triggering of Article 50 as it is now already priced in. A promise that parliament would vote on any final deal also eased immediate concerns.

From the UK perspective, global negotiations will also be important. President-elect Trump has indicated that he will look to reach a quick deal with the UK. A positive global stance on trade deals would boost overall confidence in the medium-term UK outlook which would boost confidence.

Legal challenges still a threat

Legal challenges could still play a very important role in Brexit throughout the process and there is the potential for a short-term impact if government plans to trigger Article 50 in late March are disrupted.

Last year, a High Court judge ruled that the UK government would need to consult parliament before triggering Article 50. The government appealed against the decision to the Supreme Court and the judgement is set to be announced on January 24th. The most likely outcome is that the Supreme Court will confirm the judgement against the government. This should not cause major difficulties as there should be strong support within parliament for starting the process.

There is, however, still scope for further legal challenges against the process and there is still an important risk of delays to the triggering of Article 50. In the worst case, there could be a delay of months.

Although markets are wary of difficult negotiations, a delay in triggering Article 50 would be seen as more damaging given that there would be a protracted period of uncertainty which would tend to undermine investment and damage the economy.

EU stance will be crucial

eu flag smallTo an important extent, there has still been a phoney war between the UK and EU officials before Article 50 is triggered. EU members, in particular, have insisted that there will be no negotiations until the UK formally starts the process.

Once Article 50 is triggered, the real negotiations will get underway and the underlying tone from EU officials will give an important impact. If EU negotiators led by Barnier immediately take a tough stance towards the UK and indicate that there will be very difficult negotiations, there will be a negative impact on confidence.

Given the dynamics of negotiations, there is a high risk that the EU will look to open with a hard-line stance and only move to make concessions gradually during the negotiating process.  In this context, there will is the potential for increased short-term fears that the UK will not be able to secure an acceptable deal.

The political risks from within the other EU members will be increased by the French Presidential elections with campaigning in full flow by March.  With established political parties battling to contain the increase in populist sentiment and increased support for the National Front, there will strong pressure for political parties to promote a tough stance against the UK.

The UK financial services sector will also be an important risk given the risk of relocation away from London. If there is a series of negative announcements once Article 50 is triggered and increased fears over job losses, there will tend to be downward pressure on Sterling.

UK economic trends extremely important

Overall Sterling trends will also be determined to an important extent by trends in the UK economy. Growth overall has been stronger than expected over the past few months, boosted by a very loose monetary policy and Sterling weakness. This combination is likely to provide further near-term support. If the economy maintains a strong underlying tone with the Bank of England looking to reverse August’s interest rate cut, overall confidence in Sterling will tend to improve and markets will be much less vulnerable to political concerns.

If the economy is showing signs of weakness, however, market sensitivity to political setbacks would be more acute with the currency more vulnerable to selling pressure.

Recommended for you:

Spread the love