The impact of a UK-EU trade war

On 13 June, the UK government revealed legislation that would allow it to scrap parts of the Northern Ireland protocol.

The EU’s response was to press ahead with legal action, which it had previously paused amid ongoing negotiations.

Some analysts fear the dispute could lead to a trade war between the bloc and its former member. But just how likely is this? And what are the potential implications?

Could a trade war really break out?

Neither side wants a trade war, particularly during a time of global economic and geopolitical crises. But the dispute over the Northern Ireland protocol has become a political struggle, which complicates things.

Tensions are running high, and the British government’s Northern Ireland Protocol Bill has fanned the flames, with the EU saying the legislation breaks international law.

Parliament is set to debate the bill from Monday 27 to Wednesday 29 June. If voted through, the bill will then go to the House of Lords, where it may be rejected. The government could use the Parliament Act to force the bill through, although that would take a year. If the Lords accept the bill, it could come into effect by the end of 2022.

In the event that the bill passes the Commons, and then passes or is forced through the Lords, the EU is very likely to react.

How could the EU respond?

There are two main retaliatory weapons the EU has in its arsenal, as laid out in the trade and cooperation agreement (TCA).

Scrap the Brexit deal

The first, most drastic option is to scrap the entire TCA. This would effectively put the UK in a no-deal Brexit scenario, ending tariff-free trade going both ways as well as other parts of the TCA, such as the fishing agreement and 90-day visa-free travel for UK citizens in the EU.

However, such a move requires a year’s notice, so if the EU wants to respond promptly then it may choose a different route.

One-week trade war

The second, more likely option, is that the EU will trigger article 506. This allows the EU to suspend access to its waters and tariff-free trade with only one week’s notice. According to insiders, many EU leaders prefer this fast-acting option.

What would the impact be?

Often in trade wars, the warring states will focus their attention on economically important and/or politically sensitive exports.

For instance, during the US-EU trade war, the EU targeted typically American products, like Harley Davidson motorcycles, Levi’s jeans, Jack Daniel’s whiskey and Floridian orange juice.

If the EU wanted to ratchet up political pressure on the UK, it could target exports that would cause the most political turmoil for the Conservative government. That means hitting industries associated with marginal seats or voters who expected to better off after Brexit.

Some analysts expect the bloc to target car exports from the North East of England, along with fishing and agricultural goods.

Any affected industries could see their exports to the EU dwindle as tariffs push up prices. In the EU, goods brought in from the UK could become more expensive. Businesses and consumers may turn to other suppliers, and it may add to already-rising inflation in the Eurozone.

There are also concerns that it could damage UK trade relations with the US. Following the publication of the Northern Ireland Protocol Bill, a senior US administration figure said:
‘It is true that there is no formal linkage between the protocol and a free trade agreement, but the current situation does not create a conducive environment’.

If the UK scraps the protocol, a UK-US trade deal could take longer to negotiate, and the current US tariffs on UK steel could remain in place.

Will the UK respond?

The expectation is that if the EU imposes tariffs, the UK will respond in kind, which in turn risks further escalation.

However, Brexit opportunities minister Jacob Rees-Mogg has hinted that the UK would not hit back with tariffs on imports from the EU. Rees-Mogg said:
‘Tit-for-tat retaliation of that kind is the economics of the school ground and it would damage British consumers at a time of rising prices.’

Indeed, new tariffs would raise the prices of EU-imported goods in the UK, at a time when CPI inflation is at a 40-year high and climbing.

However, as mentioned, the issue is extremely politically charged. If the government sees retaliation as a political necessity, it may be willing to risk the potential economic fallout.

Currency volatility

Brexit has had a huge impact on pound Sterling, ever since the referendum debate began in 2015. Headlines around the Northern Ireland protocol have caused big swings in GBP since renegotiations began in 2021.

The situation remains uncertain, and therefore it could infuse the pound with volatility. If the UK passes the bill, GBP could fall. If UK-EU negotiations begin anew, Sterling may rise. And if a full-blown trade war breaks out, the Pound may face significant downward pressure.

If you need to protect your currency exchanges from the current market volatility, get in touch. We can develop a personalised risk management strategy for your company, giving you stability at a time of global uncertainty.