UK Wants a Codicil to Guard Against Permanent Entrapment in EU Laws

Above: File photo of Theresa May and European Council President Donalt Tusk. Image © Number 10 Downing Street.

- Sterling finding its feet again

- EU said to offer fresh committments on backstop clause

- Morgan Stanley: Chances of 'no deal' Brexit reduced following May confidence win

The British Pound is seen extending back to recent highs on Thursday, but we would expect the currency's gains to ultimately be limited to tight ranges for the duration of the two-day European Council summit which gets underway today.

Theresa May has gone back to Brussels to tell fellow leaders the UK wants a legal assurance concerning the controversial backstop clause held in the Withdrawal Agreement. 

In short, the UK wants a legal guarantee to ensure they are not locked into the EU single market and customs union indefinitely in the event no trade agreement is agreed after the two year negotiation period. But, the EU has already said the legal text of the Withdrawal Agreement is already locked, so how can the UK get what they want, while ensuring the EU stick to their word?

"What we are looking for is something called a joint interpretive instrument. It's a codicil with legal force which means we won't be stuck in the backstop," a senior Whitehall source explained to the Financial Times.

The legal assurance would - critically - allow the DUP to budge and support the deal; recall the DUP are kingmakers in this whole process, they know May needs her, the EU know May needs the DUP and therefore the EU must produce something to satisfy the DUP.

The DUP, we believe, could live with a legal codicil.  

The codicil is a legal attachment that can be applied to the deal, without actually having to open the deal again. It's a perfect Brussels 'fudge' in that it allows them to satisfy their own commitments, while simultaneously pulling something out of the hat to allow May to get the deal across the line.

The EU need this deal to succeed, why? Because they know the alternatives going forward are either a 'no deal' or another referendum. The EU don't like referendums in that they can't be controlled, they will be wary that another in/out vote could once more go against them, while deal/no deal vote could also go against them. Referendums don't offer good odds to an institution that is all about ureaucratic certainty.

However, despite knowing how important the legal codicil is to May, and themselves, EU leaders might still not grant it.  

"I am getting strong sense Theresa May will fail to get from EU leaders the “legal” bit of the assurances she needs to get her EU plan approved by DUP and Brexiter Tories - ie no addendum or codicil to Withdrawal Agreement. So this EU Council could yet be debacle for her," says ITV Political Editor Robert Peston.

We would suggest that those watching the British Pound look out for the codicil: If one is granted, the Pound could shoot up, if not, it's business as usual and further purgatory at least until year-end.

The Pound-to-Euro exchange rate is seen trading at 1.1131, a decent 0.3% advance on the day which takes the pair closer to Wednesday's highs in the 1.1150 area. The Pound-to-Dollar exchange rate is trading at 1.2663, the week's high is still some distance off at 1.2753.

Further Options the EU Might Put Forward

Prime Minister Theresa May will be joining fellow European leaders for the December European Council gathering where it is expected further assurances over the controversial Irish backstop clause will be made. 

According to the BBC's Brussels Correspondent Adam Fleming, "EU leaders are considering a commitment to continue negotiating a trade deal with the U.K. even if the Irish backstop comes into force - to prove that they want it to be temporary."

European leaders this week committed to helping Prime Minister May get the Brexit deal ratified in the UK parliament by offering assurances that the triggering of the backstop clause is not a preferred outcome. While they refused to reopen negotiations on the Withdrawal Agreement, they have said further assurances can be offered on the political declaration.

For the British Pound what the EU offers is important: if markets believe they have made a strong, concerted gesture the feeling amongst traders will be more Conservative party rebels, and even cross-bench opponents, will get behind Theresa May and her deal.

Any concessions that narrow the resistance to the deal ultimately diminish the prospect of a 'no deal' Brexit in March 2019.

Under such a scenario we would expect Sterling to consolidate the recent gain made in the wake of Theresa May's confidence vote win.

Fleming says the latest offer being floated by European leaders "is part of a two-stage reassurance process that will start at the December summit and could continue into January."

"It’s just a draft but a clear sense of the direction the EU and U.K. are going in to provide the House of Commons with reassurance on the backstop," says Flemming.

We don't think the European Union can offer anything that can win over the DUP and the staunch Brexiteers in May's party, but we believe there is the prospect of level-headed opposition politicians getting behind the deal in the eleventh hour when it becomes clear that not voting for the deal is in fact a vote for a 'no deal'.

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The British Pound rallied through the mid-week session as markets bet that the no confidence vote called in Prime Minister Theresa May would ultimately prove unsuccessful and see her potentially strengthen her hand.

At the very least it provides some certainty in that markets know the UK leader will remain unchanged during the crucial 2019 Brexit as a new leader might have been more inclined to opt for a 'no deal' Brexit.

"The Pound had already rallied in expectation of the result, so the drop back from the highs is not surprising. But now the focus for Sterling goes back to Brexit, and there the outlook is not at all promising," says Chris Beauchamp, Chief Market Analyst at IG.

It is noted that while the Prime Minister has survived the vote of no confidence in her leadership, in reality little has changed.

"The vote, 200-117, was not a thumping result for the PM, and while it means she remains in place, it is clear that her authority has suffered a blow, especially given that it required a promise that she would not stay for the next election," adds Beauchamp.

However analysts at investment bank Morgan Stanley are more constructive on the outlook saying the victory goes some way in lowering the prospect of a 'no deal' Brexit.

May's victory, "means she cannot be challenged for another year, closing the route to a no deal outcome via Brexiteer victory in a Conservative party leadership election and a change in government policy. Even though a no deal outcome is the legal default, we see it as a low probability, given the existence of alternative courses of action," says Economist Jacob Nell with Morgan Stanley in London.

Nell concedes the arithmetic to the deal passing through parliament remains challenging, however May's victory, "especially if combined with a protocol providing additional legal assurance on the temporary nature of the Irish backstop, could increase support for the Brexit deal in the vote promised by January 21."