Pound Dented by Brexit Disappointment but May's Letter Suggests Deal is Coming

Image © European Union.

- GBP hits the ropes after Art 50 extension disappoints market.

- But May tells EU she's "confident" MPs will back deal this month.

- Threatens MPs with pivot toward customs union and single market.

The Pound hit the ropes on Wednesday after the market was left disappointed by a government request for only a short delay to the UK's exit from the EU, but nonetheless a deal and the "softest" of all possible orderly exits now appears to be in the pipeline. 

Prime Minister Theresa May has requested a 90-day extension to the Article 50 negotiating window intended to run between March 29 and June 30. 

"I'm not prepared to delay Brexit by any later than 30th June," PM May said in the House of Commons.  

The Telegraph subsequently reported that Brexiteers within the Conservative Party are up in arms over the request, claiming that they will use a gathering of the influential 1922 committee this evening to demand that she resign.

They can't evict her from office for at least another eight months because a majority of MPs already saved her from that fate in December, giving her a 12-month period in which another ballot of confidence cannot be called.

"It’s sufficient to say here that the GBP is underperforming within G10 so far today as FX investors absorb two things: 1) “cliff edge risk” is not dead, but probably just delayed and 2) a long Article-50 extension is by no means a given. We simply cannot get enthusiastic about owning the EUR and the GBP now," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. 

Above: Pound-to-Euro rate shown at daily intervals.

Markets dislike anything that looks remotely like Brexit, and before Wednesday had come to hope the requested extension could be as long as two years, creating greater scope for a general election or another referendum to see the entire pursuit called off. 

That, and speculation of a renewed threat to PM May's ability to remain in office, explain why Pound Sterling suffered so much Wednesday. But the text of PM May's latest letter to the EU, when read in conjunction with the EU Withdrawal Agreement, make reasonably clear the game that could now be afoot. 

This is one that will see either the House of Commons back the Withdrawal Agreement before long, or the withdrawal agreement supplemented with a new commitment by the UK to remaining a member of the EU customs union and single market (regulatory area) after Brexit day.

"I also intend to bring forward further domestic proposals that confirm my previous commitments to protect our internal market, given the concerns expressed about the backstop," May told the European Council's Donald Tusk. 

The Prime Minister has previously told the Democratic Unionist Party that if the so-called "Northern Irish backstop" within the EU Withdrawal Agreement is activated then any new EU law or regulations imposed on the province will also be imposed on the UK as a whole.

That promise appeared geared toward allaying unionist concerns about the "breakup of the United Kingdom" that could be brought about by the "backstop" part of the agreement. Based upon her letter, she now appears to be preparing to make customs union and something like single market membership a part of her official plan.

The letter makes clear the above offer to the DUP, and potentially other options too, will be put to the House of Commons via a non-binding motion next week. The substance of the offer is exactly what many government and opposition MPs who oppose Brexit have been arguing for all along.

Passing the motion through the commons will likely require support from the opposition because, as much as many of the government's MPs will back it, most of the Brexiteers in parliament also happen to be Conservative Party MPs and have already said they won't countenance such policy. 

"PM May promised lawmakers she will give Parliament the chance to vote on an amendable motion on Brexit next steps by 25 March. Giving Parliament greater control over the Brexit process ultimately sets the stage for softer Brexit options, another referendum or a general election. This would be positive for GBP," says Elias Haddad, a strategist at Commonwealth Bank of Australia.

Above: Pound-to-Dollar rate shown at daily intervals.

However, the rub for opposition MPs and Brexiteers, not to mention another potential boon for Sterling, is that after the non-binding "soft Brexit" motion gets the nod the Prime Minister intends to put her EU Withdrawal Agreement before Parliament again.

"If the motion is passed, I am confident that Parliament will proceed to ratify the deal constructively. But this will clearly not be completed before 29 March 2019," May wrote to Donald Tusk on Wednesday. 

May is betting it'll receive enough support to pass this time around, presumably because of the threat seemingly posed to Brexiteers by the non-binding motion, even though backing the Withdrawal Agreement looks likely to lead toward exactly the same kind of outcome as the non-binding motion would deliver if it dictated the process.

The EU Withdrawal Agreement will, ironically, mean markets do not clap eyes on anything that looks remotely like Brexit until at least the end of 2020, when the so-called implementation period ends. Nothing, other than a Brexit in legal terms and on paper, actually changes or is to be implemented during that implementation period though.

And even then, the withdrawal agreement itself and PM May's comments in relation to it make clear enough that what will most likely be produced in the next stage of the negotiations is a future relationship defined by customs union membership and something that looks a lot like single market membership. Because of the "backstop".

The backstop enshrines in an international Treaty a commitment that will see the government forced to impose on the UK many existing and yet-to-be-made EU laws on a potentially-indefinite basis and without any ability to influence those laws or EU institutions. The UK will also form part of the EU's customs territory.

That's unless, of course, the UK is willing to allow Northern Ireland to be annexed by the EU in the event the backstop is activated. Or, unless the government is able and willing to satisfy the EU's demands in the next stage of the negotiations, whatever those demands eventually turn out to be.

Such a structure could be said to create an incentive for the EU to remain perpetually unsatisfied with UK proposals for the future relationship. This why many MPs have expressed deep-seated opposition to the EU Withdrawal Agreement and some have even gone so far as to describe it as a trap.

PM May has said repeatedly that "no British Prime Minister" could agree to see Northern Ireland annexed, which leaves only one other possible outcome in the event Brexiteers give way and back the withdrawal agreement later on this month. That's customs union and some level of "single market" membership.

 

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