Brexit occurred on January 31, 2020, and we are now in the transition period until December 31. Therefore, rules and regulations in the UK are still aligned with those in the European Union, but the United Kingdom is no longer a member state, hence talk of the EU-27 rather than the EU-28.
Possible outcomes and implications for the British pound and equities
An extension of the transition period has been ruled out, so the UK either leaves with or without a deal. Both the UK and the EU have shown no willingness to compromise on certain major issues including:
- Leveling the playing field – the EU wants the UK to mirror their rules on workers’ rights, environmental regulations, state aid and subsidies. The UK wants the independence to set their own rules.
- Fishing rights – the UK wants full access to the EU to sell their fish, while the EU wants to fish freely in UK waters. Fishing is a very small part of Britain’s trade, but overfishing of UK waters was a critical issue in the 2016 referendum campaign.
It will become more apparent as we approach the end of the year that the British government is running out of options if no deal is agreed upon. Expectations for a deal are not high, as evidenced by weakness in its currency and equity market.
A weaker sterling would support outperformance in the export sectors, and domestic companies, especially those which rely on imported raw materials, would be more challenged. In particular, food will cost more as there will be tariffs levied, and this will dampen domestic spending.
The current expectation is for currency weakness to be more limited moving forward, as the dollar has also started to weaken, and the market has started to increasingly discount no deal being agreed to by the end of the year.
While there is a possibility of a UK-EU trade deal being agreed upon by year-end, there are still wide disagreements with little sign of compromise on either side. Both UK Prime Minister Boris Johnson and German leader Angela Merkel have said plans should be made for a no deal scenario.
Outlook for trade deals
There have been reports that a post-Brexit trade deal with Japan is close, but it was not announced earlier this month as hoped. The deal hopes to go further than the existing EU-Japan deal it will replace for the UK, with concessions on auto tariffs, digital trade and investor protections. New Zealand also poured scorn on thoughts of an imminent deal. No deal is likely to be signed with the U.S. amidst the upcoming Presidential election in November.
A deal with the EU needs to be agreed on by October in order to be ratified by year-end in the British and EU parliaments. The final round of negotiations is scheduled to end on October 2, the latest potential deal date if it is then to be ratified by the parliaments of both the UK and EU in time for December 31. The current round of talks is set to end soon, but based on past form, there is little chance anything will be agreed upon before October, and possibly not until even later. The UK has attempted to find areas where they agree, and then proceed from there, but the EU has been adamant that all issues must be discussed together, a process which has paralyzed any kind of progress on the talks.
While a UK and EU trade deal remains elusive to date, the UK has agreements with around a dozen countries, including South Korea, Israel and Switzerland, though clearly one with the EU is the most critical.
With the likelihood of a deal with the UK and EU not being signed by year-end, the UK will then be forced to trade on World Trade Organization (WTO) rules after December 31. The average WTO tariff for the EU is 11% for agricultural goods and 16% for animal products. The UK exports 46% of their goods to the EU, and 53% of imports come from the EU. But both sides should be keen to agree on a deal in order to speed up the economic recovery that was already languishing prior to the current COVID shock.
COVID-19 – a shock to the economy
The UK has been badly impacted by COVID. The death rate from COVID in the UK has been on a par with the worst in Europe. Although there has been some debate about the UK classifying more deaths as COVID-related, it is clear that the UK has seen high excess mortality. So far though, they have avoided the second wave which most of Europe appears to be experiencing.
The UK opted out of EU procurement plans for personal protective equipment and ventilators at the height of the pandemic when individual EU states appeared to be competing with each other for vital equipment. They also opted out of the EU vaccine program, as this would have prevented Britain from negotiating deals on their own. They have built up a stockpile of 250 million potential vaccines split between four candidates led by the Jenner Institute in Oxford which is working with AstraZeneca on one of the most promising vaccines.
The COVID pandemic has reduced the likelihood of a deal, as it is clear that the pandemic has changed the outlook for not just the UK, but the global economy, and the UK government will likely want a free hand in reshaping theirs, which they would not have if are still tied to the EU with a trade deal.