UK Issues Fresh Brexit Demands, Pound Sterling Recovery Hampered By UK-EU Trade War Fears

The Pound Sterling has recovered some ground on Wednesday with a correction following sharp losses early this week as equities have regained ground.

The threat of further escalation in the UK-EU trade war has, however, added to unease over the delta variant in curbing sentiment, especially with reduced speculation of a more hawkish Bank of England stance.

The Pound to Dollar (GBP/USD) exchange rate has recovered from 5-month lows near 1.3570 to 1.3670 as the US currency has corrected lower.

The Pound to Euro (GBP/EUR) exchange rate has also recovered to 1.1600 from 8-week lows near 1.1550, but below 1.1660 at the end of last week.

The Pound will still tend to strengthen if global risk appetite strengthens, but the threat of under-performance will continue and with substantial downside risks if equity-market sentiment slides again slides again.

UK Government Demands Wholesale Changes to Northern Ireland Protocol

At present, the Northern Ireland trade protocol between the EU and UK is not being implemented in full as a grade period is still in operation for many of the customs checks contained within the agreement.

This grace period is due to end in September with more stringent checks on goods entering Northern Ireland from Britain.

In testimony to the House of Lords, UK Brexit Minister Lord Frost stated the full deal should not be implemented, as it risked unrest and damage to business.

According to Frost there is a; “growing sense in Northern Ireland we have not found the right balance, seen in an ongoing febrile political climate, protests and regrettable instances of occasional disorder”.

He urged the EU to change its stance, saying: “We cannot go on as we are.”

Frost also called on the EU to “quickly agree a standstill period” in order for further discussions to take place.

“We see an opportunity to proceed differently, to find a new path to seek to agree with the EU through negotiations, a new balance in our arrangements covering Northern Ireland, to the benefit of all.”

Frost added that Britain wanted a new “balance”, which meant governance of the accord was no longer policed by EU institutions and the European Court of Justice, and a “normal treaty framework” which was “more conducive to the sense of genuine and equitable partnership”.

UK Keeps Article 16 Threat on the Table

As far as invoking article 16 is concerned, which would allow it to suspend parts of the Brexit deal, Frost stated that the government believed that using it would be justifiable but added

“Nevertheless, we have concluded that it is not the right moment to do so.”

The UK also announced fresh proposals to ease trade friction. In effect it wants no customs checks on goods which are solely destined for Northern Ireland while there would be checks on goods which are destined for the Republic of Ireland.

EU Will Protect the Single Market

The EU’s over-riding priority is to protect the single market and be extremely wary over any proposals which jeopardise this position.

David Mcallister, Head of the EU Parliament’s Trade Committee, commented that the protocol should not be undermined and that permanent flexibilities are not acceptable.

The Irish government also noted that there was already enough leeway in the protocol and it did not need revising.

Invoking article 16 would risk serious retaliation from the EU.

An EU spokesman added; ”we will not agree to renegotiate the Northern Ireland protocol.”

MUFG remains more cautious over the near-term Pound outlook.

“Delta variant uncertainty and now potentially an escalation in UK-EU tensions may see rate hike expectations remaining subdued over the remainder of the summer period which could mean further GBP underperformance over the short-term.”

“The UK government policy paper on the post Brexit trade in Northern Ireland is likely to put the UK on yet another collision course with the EU. This suggests that sterling’s recovery back to short-term fair value is not imminent.”

ING added; “The EU is unlikely to accept these changes, reinforcing the prospect of a fresh trade conflict. To make matters worse still, Foreign Secretary Raab has criticised EU plans for a post-Brexit deal for Gibraltar.”

Rabobank FX strategist Foley also expressed caution; “Another wave of news suggesting that the EU and the UK are at odds regarding the Northern Ireland protocol will not help sentiment today.”

According to HSBC, less favourable news may now be priced in, but sentiment is liable to remain weaker in the short term; “Perhaps GBP’s fall since the start of June prices in some of these challenges, but the headlines suggest this consolidation could be challenged afresh.”