Pound Falls after Barnier says Talks "Hang in the Balance", France Ramps up 'No Deal' Rhetoric

Above: Michel Barnier updating media on state of EU-UK trade negotiations. Photographer: Claudio Centonze. © European Union, 2020. Source: EC - Audiovisual Service

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Pound Sterling went lower against its main rivals on Wednesday following confirmation that EU and UK negotiators are unlikely to strike a post-Brexit trade deal this week.

Following days of intensive talks EU Chief Negotiator Michel Barnier has told EU ambassadors in Brussels that "a deal hangs in the balance ... differences still persist on the three main issues".

The pound is the worst performing major currency of the day on the back of the developments, although the fact that negotiations are continuining should limit the downside.

France's President Emmanuel Macron has also said on Wednesday he's keeping a close eye on Brexit trade negotiations and won’t sign up to anything that goes against France’s long term interests.

The Times reports France is advocating a view that the EU accepts a 'no deal' outcome to negotiations if the UK does not conceed further ground, believing the country will be more willing to make concessions in 2021 once the realties of 'no deal' become evident.

However, political commentator and journalist Andrew Neil explains the risks of France's stance succinctly in the following observation:

"Could be just last-minute tactic. But if it's more than that, it is a significant miscalculation by EU. UK will not return cap in hand. More likely to conclude that if a liberal country, free market, free trade economy, backing net zero, with close military/security ties to Europe can only get a 'punishment beating' deal with EU then the UK will proceed with no deal and make the best of it, whatever the short-term pain. Instead of being chastened, UK likely to be defiant. And EU/UK relations would be in the freezer for years. Not good."

Markets agree with the view the situation is "not good".

Above: GBP fell against all its major peers on Wednesday.

In any case, the developments suggest a deal is not likely this week and the focus now turns squarely on next week's meeting of EU leaders at the December European Council summit, where a final decision could be agreed.

Expect foreign exchange markets to express growing anxiety on the matter by paring exposure to the pound.

The Pound-to-Euro exchange rate has fallen back 0.33% in Wednesday trade to quote at 1.1080, the Pound-to-Dollar exchange rate is quoted 0.40% lower at 1.3365.

"While the UK-EU trade talks have taken longer than originally planned, our economists continue to expect a ‘thin’ free trade agreement in goods; the EU Council meeting on 10-11 December looks like an achievable goal to see a final agreement, in our view," says Sharon Bell, a strategist with Goldman Sachs in London.

Goldman Sachs say the UK is a "buy" as a deal is likely to unlock pent-up demand and stoke an economic recovery in 2021, that should ultimately benefit Sterling.

While the observation that talks are unlikely to end this week will disappoint those market participants positioned for a near-term deal, the delay is unlikely to be a surprise to most given the knack of EU and UK negotiations to run down to 'the wire'.

Political commentators and briefings to the press are yet to indicate that talks are close to failure, an observation that should limit Sterling weakness.

Bloomberg reports that the intensive talks being held in London are making progress, quoting two officials as saying the general mood on both sides is one of optimism.

The report adds UK and EU teams hoping that an agreement can be reached on Friday or over the weekend, with one official saying that while a final picture was beginning to emerge, the situation remains incredibly delicate.

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An interesting take on the situation is provided by the Bloomberg report: while we noted earlier in this article that the December 10-11 is seen by many as the moment at which a deal happens, apparently Barnier is keen to avoid this scenario.

People familiar with the EU position said negotiators are trying to avoid talks running into next week to prevent them having an impact on preparations for the European Council summit.

"Not only are European governments occupied with a row over the EU budget, the bloc’s negotiating team, led by Barnier, is concerned that presenting leaders with anything other than a signed-and-sealed deal would leave an agreement vulnerable to being unpicked at the last moment," says the report.

It is believed EU states are pressing Barnier to show them any deal with the UK before it is agreed, amid concerns the bloc’s chief Brexit negotiator may concede too much ground in the final days of negotiation.

"Barnier will be asked to relay the message to the commission the member states would like to have prior scrutiny of a possible agreement before closing it. Being in the dark makes people nervous," an EU source told The Guardian.

The pound is widely expected by the analyst community to rally on the successful completion of a Brexit deal, even though the scope of that rally remains up for debate.

Some analysts say the pound can only be expected to rally modestly as it will soon become apparent that Brexit poses significant challenges for the UK economy once the UK leaves the bloc in January.

"Expectations that a trade deal with the EU can prevent a no-deal Brexit are flying high. Nevertheless, euphoria in case of a deal could sober up to realism, because a basic free-trade deal only remains a hard Brexit. Therefore, we stick to a Neutral long-term GBP outlook and do not expect the pound to join European currency strength," says David Alexander Meier, an economist at Swiss private bank Julius Baer.

Others are however more confident in Sterling's upside potential, with one economist forecasting a substantial rally in the pound againt the euro and dollar that could see GBP/EUR eventually hit 1.25 and GBP/USD 1.70.