UK-EU tensions appeared to hit a new low

  • 11th September 2020

What has happened

Thursday proved to be another volatile day for investors, as US equities swung between gains and losses before taking a sharp leg lower after the European close. With US markets falling for the fourth time in five sessions, investors appeared to be weighing a trio of negative developments: US Congress looked to be stuck in a deadlock around the size and scope for any additional government spending, as a slimmed down US stimulus bill failed to pass the Senate; the European Central Bank (ECB) disappointed hopes for a more dovish message following their latest monetary policy meeting; and UK-EU tensions appeared to hit a new low, with the EU threatening to sue the UK government over plans to breach international law.

Brussels introduces a new Brexit divorce deadline

On Thursday the EU gave the UK government an ultimatum to withdraw the Internal Market bill by the end of September or face legal action. With the EU determining that the proposed bill violates the terms of the UK-EU Withdrawal Agreement, trust was evidently in short supply. In a terse statement, the European Commission ‘reminded the UK government’ that they would ‘not be shy in using’ legal remedies, likely to include recourse to the European Court of Justice. Meanwhile, the latest UK-EU spat risks spilling over into broader trade hopes that the UK is eyeing with the US. Earlier in the week, the US House of Representatives Speaker Nancy Pelosi warned that there is ‘absolutely no chance’ that Congress would pass a UK-US trade deal which might ‘imperil’ the Good Friday Agreement by risking a border on the island of Ireland. Despite the growing pressures, UK Cabinet Minister Michael Gove insisted that the government ‘could not and would not’ withdraw the bill. With brinkmanship in the driving seat, Sterling fell -1.5% against the US Dollar and -1.6% against the Euro, the biggest daily drops since 18 March during the worst of the pandemic selling. Sterling has now fallen -4.5% versus the US Dollar and -3.2% versus the Euro since the start of the month. While UK-EU talks are due to continue with a ninth round next week, expectations for an immediate break-through are low.

ECB chooses not to stand in the way of Euro strength for now

'We do not target the exchange rate' said European Central Bank (ECB) President Christine Lagarde at Thursday’s press conference. To be fair, such an explicit target was never on the cards. But while the euro currency's impact was 'extensively discussed', it is somewhat surprising that the language wasn't more accommodative. While the scripted introductory remarks acknowledged that the ECB would 'carefully assess...developments in the exchange rate', this still feels rather muted given the ECB Chief Economist Philip Lane's comments last week that 'the euro dollar rate does matter’. With the Euro spiking up through $1.19 against the US Dollar immediately following Lagarde's comments before paring back some of the gains later in the session, the Euro has now strengthened close to 10% against the US Dollar since mid-May. This risks an impact for prices, where inflation last week for August was negative for the first time in over four years, as well as relative international competitiveness for Eurozone businesses, where close to half the region's GDP is driven by exports, according to World Bank 2019 data. While the ECB appears relaxed around currency pressures for now, left unchecked however, continued Euro currency strength risks creating an unwelcome headwind for the relative pace and scale of the Eurozone’s nascent recovery.

What does Brooks Macdonald think

The hitherto lack of progress in UK-EU trade negotiations has this week appeared to have actually gone into reverse. If investors had thought the UK PM Boris Johnson’s self-imposed 15 October deadline for a deal was short enough, the new effective deadline from Brussels of 30 September is now even shorter. With both sides currently refusing to give ground over the latest impasse, and with less than 3 weeks to find a solution, volatility for both Sterling and UK risk assets is likely to remain elevated.

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