The pound remained buoyant on Tuesday but struggled to find meaningful gains on the back of some mixed employment figures.
At times, Brexit optimism has offered some relief for British markets amid the pandemic as hopes of a breakthrough deal seemed within sight, while a no-deal scenario has weighed on market mood.
With the end of the transition phase fast approaching on 31st December, UK-EU talks are entering their final stages.
These final negotiations will likely drive additional volatility in the pound, but what are the final hurdles? And what could this mean for currency markets and GBP exchange rates?
How did we get here and what do the two sides want?This year, the pound to euro exchange rate has hit highs of €1.20 to a low of €1.06 in March as the UK’s first lockdown hit, before trading in a narrower range around €1.10 - €1.12 in October and November.
More recently Sterling has begun to edge higher as UK-EU trade talks reopened at the eleventh hour, following UK government threats to walk away from talks in October.
Talks have ping-ponged between London and Brussels, but at the time of writing it’s still unclear whether we’re headed for a trade deal or not.
However, there appears to be belief among investors that the UK and EU will reach an agreement despite talks recently having to be suspended due to an EU official testing positive for Covid-19, and a missed deadline of a draft deal before an EU leaders’ summit.
But, as one EU diplomat recently said, the chances of a trade agreement are still “50-50”, which largely reflects the situation through much of November.
EU fishing rights and state aidLord David Frost, the UK’s chief Brexit negotiator, recently said that there is “still quite a way to go” to resolve outstanding issues, such as EU fishing rights in British waters, along with limiting state aid to companies.
In addition, the European Commission’s spokesman also commented that they have not “yet found a solution on fisheries” and that the two sides were still a long way apart.
If this situation were to change, we could see increased volatility in Sterling, positive or negative, as fishing rights have remained a hotly debated topic between the two sides.
Could the Irish border issue compromise a UK-US trade deal?Both the EU and the UK want to avoid border checks between Northern Ireland and the Republic of Ireland, which Prime Minister Boris Johnson aimed to solve with the Northern Ireland protocol, and was agreed in the Withdrawal Agreement with the EU.
However, since the UK government passed the Internal Market Bill aimed to allow goods to pass freely across the Irish Sea, tensions between the UK and EU have risen.
The EU started legal action against the UK believing the Internal Market Bill breached international law as it would override parts of the Withdrawal Agreement, which sent Sterling plummeting.
Significantly, this could now also jeopardise a post-Brexit trade agreement with the United States following Joe Biden’s US election win and Democrats holding the House of Representatives.
US House Speaker Nancy Pelosi had already warned that there was “absolute no chance” of a UK trade deal with US Congress should London break its pact with the EU over the Irish border.
Mrs Pelosi said: “The U.K. must respect the Northern Ireland protocol as signed with the EU to ensure the free flow of goods across the border. If the U.K. violates that international treaty and Brexit undermines the Good Friday accord, there will be absolutely no chance of a U.S.-U.K. trade agreement passing the Congress.”
Government preparations and an Australia-style BrexitWith about a month to go until 1st January 2020, when the UK will have officially left the EU regardless of terms, the British Government has urged businesses and citizens to prepare.
And in mid-October, Boris Johnson told the UK to be ready for an Australia-style trade deal, which would mean the UK will operate with the EU on World Trade Organisation (WTO) rules.
As far as we know, this is the type of Brexit that could still happen. But again, all this could change if UK-EU trade talks reach a consensus.
Leaving with an Australia-style trade deal would be a significant change to securing a post-Brexit trade deal with the European Union, and this would likely limit the pound as the UK engages in a radically different economic environment outside of the Eurozone.
Conversely, if the UK and EU come to a compromise before December 31st, Sterling could head higher as this would maintain the status quo that is usually preferred by markets.
Brexit, coronavirus and GBP exchange ratesThe pound will face heightened volatility as the British economy faces significant challenges from the ongoing coronavirus restrictions, a potential drop in fourth quarter growth, and Brexit uncertainty.
However, with recent positive news of progress towards a coronavirus vaccine, the pound may benefit from more upbeat market trade, and increasing optimism a post-Brexit trade deal of some sort will be concluded by the end of the year.
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