Pound Sterling Rises as Windsor Framework Erases Lingering Trade War Fears

•  Deal might bring an end to years of uncertainty
• As scale of concessions secured unexpected
• GBP rallies on the day
• But gains could prove short-term in nature
• As FX markets remain focussed on economic data pulse

Above: Windsor, United Kingdom. The Prime Minister Rishi Sunak holds a joint press conference with the President of the European Commission Ursula von der Leyen in Windsor Guildhall. Picture by Simon Walker / No 10 Downing Street.

The British Pound extended a rally against the major currencies following the previous day's news that the EU and UK reached an agreement on the Northern Ireland protocol which potentially opens the door to a period of improved relations between the two sides and eliminates any lingering fears of a potential trade war between the two sides.

It wasn't so much the fact that an agreement had been reached that surprised currency markets; after all, this had been signposted for some time. Rather, it was the scale of the concessions Prime Minister Rishi Sunak secured from Brussels that was unexpected, meaning the deal could prove durable and therefore truly bring an end to years of uncertainty.

Pound Sterling was the best-performing major currency after the announcement of the Windsor Framework, a new treaty that would secure Northern Ireland's position in the United Kingdom as well as the EU's single market, with gains extending into the Tuesday session.

The deal would smooth the movement of goods and services between the rest of the UK and Northern Ireland while Sunak said it would also give Northern Ireland politicians an effective veto over any EU single-market laws that were perceived as detrimental to the territory.

"We have now made a decisive breakthrough," said Sunak in a press conference alongside Ursula von der Leyen, EU Commission President. "We have removed any sense of a border in the Irish Sea".

Above: GBP outperformance was seen across the board, suggesting GBP-specific drivers were at play.

The rally in the Pound suggests markets see the deal as a sign the EU and UK are mending relations following a fractious few years caused by squabbling over the matter of Northern Ireland.

At a press conference alongside, EU Commission President said the EU would move to immediately bring the UK into the Horizon Europe scientific programme as soon as the deal had been put in place, signalling the potential for an era of improved cooperation.

"A deal would be a longer-term positive for the pound," says Shaun Osborne, Chief FX Strategist at Scotiabank.

The deal, if adopted, removes the prospect of a trade war, a lingering concern that might have been holding investors back from investing in the UK economy.

For the Pound, the removal of any lingering risk premium is supportive.

"The direct impact on activity of freer trade between GB and NI will be small, but in effectively killing Johnson’s NI protocol bill, yesterday’s agreement is a significant step back from a potential trade war between the UK and EU. We are tactically long GBP (against EUR) in this week’s Trade of the Week, against our medium-term negative bias," says Adam Cole, Chief Currency Strategist at RBC Capital Markets.

The Pound to Euro exchange rate rallied to a high of 1.1370 in the wake of the developments, and the Pound to Dollar exchange rate rallied to a high of 1.2056.

It also rallied against all the major G10 currencies, confirming it was indeed news of a deal that was driving the FX market.

"On the announcement of a deal, and then again following any sign-off in UK parliament, we would expect to see modest positive moves for both sterling and UK equites," says Kallum Pickering, an economist at Berenberg Bank.

"A breakthrough deal on NI could mark a line in the sand when six and a half years of damaging Brexit uncertainty finally comes to an end. Lifting the threat of a tit-for-tat trade war with the UK's biggest market, the EU, is exactly what its businesses and financial markets need," he adds.

All eyes now turn to the DUP, the unionist party that walked away from forming a government in Stormont in protest of the Northern Ireland Protocol.

In a statement, the DUP said "it is clear that significant progress has been secured across a number of areas whilst also recognising there remain key issues of concern. There can be no disguising the fact that in some sectors of our economy EU law remains applicable in Northern Ireland."

But the new agreement will allow the government in Northern Ireland to have an effective veto on new rules imposed by the EU, something designed to bridge the so-called democratic deficit.

This 'deficit' would mean Northern Ireland was a rule-taker when subject to EU laws that were still required to ensure the province remained in the EU's single market, to avoid a hard border on the island of Ireland.

Sunak says the deal addresses this problem. "We're introducing a new Stormont Brake," said Sunak. "The elected Assembly can pull the brake for changes to EU goods rules that would have significant and lasting effects on everyday lives. When pulled, the UK government will have a veto. This gives Northern Ireland a powerful safeguard."

"Any deal is a mild GBP positive. In this context and in the light of recent USD gains we would note that the GBP/USD correction, back towards strong support at 1.1915, in line with the 17 February low looks increasingly attractive as UK recession risks moderate. The early week risk rebound, exemplified by the rally in US equity futures, points towards 1.2010/15," says Jeremy Stretch, a foreign exchange strategist at CIBC Capital Markets.

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Above: GBP/EUR (top) and GBP/USD shown at 15m intervals, capturing the reaction to the Brexit news.

The Windsor Agreement means Northern Ireland will now return to UK jurisdiction for tax laws and a new medicines agreement will ensure that all drugs approved in the UK will be available in Northern Ireland.

Initial comments from key Conservative Party members that have proven 'hawkish' on Brexit in the past suggest Sunak should be able to see it through Parliament without too much hassle.

"I think this is a win," says Northern Ireland minister Steve Baker, who was a leading member of the group of MPs who brought down Theresa May's government over her proposed Brexit deal.

Baker said he is "earnestly and enthusiastically" supporting the new Windsor Framework, and he hopes the European Research Group of MPs will feel able to "back this deal and move on".

"If Prime Minister Sunak manages to push through his deal with the EU on the Northern Irish protocol, for the first time since 2016 the extreme Brexiters will have failed to impose their view on the UK government," says Gilles Moëc, Group Chief Economist at AXA Investment Managers.

If the political uncertainty posed by 'unfinished business' on Brexit - and the threat of a trade war - comes to an end, economists at Berenberg Bank say the UK's healthy fundamentals will re-assert themselves.

Such fundamentals include well-capitalised banks, cash-flush households and firms, and well-regulated markets.

"A breakthrough deal would suit our above-consensus real GDP calls for the UK over the next three years," says Pickering.

After a mild 0.8% (consensus: 0.7%) contraction in 2023 Berenberg expects the UK to grow by 1.6% (0.9%) in 2024 and by 1.7% (1.5%) in 2025.

"It would be useful for the government to make improved relations with the EU an early priority. A sense that the UK is seeking to reduce Brexit's adverse effects on potential growth would help generate confidence that the government is putting a higher priority on supply-side issues," says Michael Saunders, Senior Economic Advisor at Oxford Economics.

The Pound's reaction to the deal was notable, however, the gains could prove short-term in nature.

This is because the benefits of any Brexit deal will be seen over the longer-term, should business investment begin to improve, leading to better economic outcomes.

The short-term direction in Sterling will instead continue to be dictated by incoming domestic economic data, expectations for the outlook of Bank of England interest rates and global market confidence.

The positive momentum for Sterling is likely to remain limited though as it is inflation developments and the monetary policy reply to these that drive Sterling as decisive factors," says You-Na Park-Heger, FX Analyst at Commerzbank. "In this context we remain sceptical for Sterling."