How Does The Brexit Transition Process Impact The GBP?
The surprise outcome of the 2016 United Kingdom Brexit Referendum sent valuations of the British pound sterling (GBP) into chaos. Upon the final vote tally coming in at 51.9% for “leave” to 48.1% for “remain,” the voting public showed its support of the U.K. withdrawing from the European Union (EU).1)Retrieved 23 March 2018 http://www.bbc.com/news/politics/eu_referendum/results The aftermath of the Brexit vote made it clear that a new era for both the U.K. and GBP had officially started.
A majority of the financial community believed a vote in favour of Brexit was improbable at best. The position was not unfounded, with the final electoral results showing that much of the U.K. supported ongoing membership in the EU:
|Wales||52.5%||47.5%2)Retrieved 23 March 2018 http://www.bbc.com/news/politics/eu_referendum/results|
Fueled by concerns over fair trade, immigration and national security, England proved to be the deciding factor in the U.K.’s exit from the EU. Boasting the largest portion of the U.K.’s electorate, England’s edge of 1.9 million votes was the primary reason the “leave” option prevailed.
Surrounded by political and economic uncertainty, currency markets facing the GBP reacted negatively to the idea of a fully autonomous U.K. Pricing volatility reached dangerous levels for the pound sterling, and values fell more than 10% in the hours after the vote was made final.3)Retrieved 23 March 2018 http://www.businessinsider.com/the-pound-in-the-year-since-the-brexit-vote-2017-6
This currency market fallout marked the beginning of a tumultuous period for the GBP. Unique challenges have presented themselves throughout the process of the U.K. formally exiting the EU. From the Article 50 enactment of the Lisbon Treaty to a pending Scottish Independence Referendum, the transition following Brexit has brought the future status of the GBP into question.
The Beginning Of The Brexit Transition: Enactment Of Article 50
Article 50 of the Lisbon Treaty is the section of EU law that outlines the process for a member state to formally exit the union. Article 50 includes five specific provisions:
- Any Member State may decide to withdraw from the Union.
- Upon the Member State notifying the Union of its intention, an agreement shall be negotiated between the State and Union. It will specify arrangements for the State’s withdrawal and future relationship with the Union.
- Agreed upon Treaties between State and Union will cease to apply two years after date of entry into the withdrawal agreement unless extended through unanimous consent of Member States.
- The Member State shall not participate in the discussions of the European Council.
- A State may ask to rejoin the Union, subject to the procedure in Article 49.4)Retrieved 23 March 2018 http://www.lisbon-treaty.org/wcm/the-lisbon-treaty/treaty-on-european-union-and-comments/title-6-final-provisions/137-article-50.html
In November 2016, a legal challenge halted the triggering of Article 50, citing the need for a Parliamentary vote to first be conducted. The challenge was upheld, prompting an instant 1.2% gain in the GBP against the United States dollar (USD).5)Retrieved 24 March 2018 http://www.businessinsider.com/the-pound-in-the-year-since-the-brexit-vote-2017-6#november-3-2016-9 The market’s optimism over the U.K. potentially staying in the EU lasted for several months until spring 2017.
In March 2017, Parliament voted to pass the Article 50 bill, which effectively cleared the way for invocating said article. Upon Parliament’s decision hitting the news wires, the GBP dove more than 0.7% against the USD.6)Retrieved 25 March 2018 http://www.businessinsider.com/pound-price-movements-on-tuesday-march-14-2017-3 The falling GBP was a product of renewed scepticism over the future of U.K. economic prowess and procedural uncertainty surrounding the Brexit transition process.
Article 50 was officially invoked by British Prime Minister Theresa May on 29 March 2017. When May’s signed letter was received by the European Council, the two-year window for transition negotiations commenced. In the immediate aftermath of Article 50 being triggered, the GBP fell 0.3% against the USD, extending post-Brexit Referendum losses to 17.5%.7)Retrieved 25 March 2018 https://www.marketwatch.com/story/british-pound-under-pressure-ahead-of-brexit-trigger-2017-03-29
Executing The Transition: The Divorce Bill
Reaching a deal between the U.K. and EU regarding the actual conditions of withdrawal is a multifaceted endeavour. Ongoing financial obligations, the preservation of existing trade relationships and the Ireland/North Ireland border are a few items integral to the discussion.
Transition dealings officially began in November 2017 with the negotiation of the “divorce bill” between the U.K. and E.U. The divorce bill outlined a cash settlement to be paid by the U.K. in compensation for its share of existing EU spending commitments. Payments are to be made over time and are estimated at 13% of the total EU budget, upwards of £50 billion.8)Retrieved 26 March 2018 https://www.independent.co.uk/news/business/analysis-and-features/brexit-divorce-bill-latest-deal-cost-impact-uk-how-big-eu-david-davis-juncker-barnier-a8082311.html
While some view the payment as unreasonable, economists argue that the divorce bill will actually save money in the long run. The cost of a “Hard Brexit,” one with no transition deal, may cost the U.K. as much as £190 billion in economic fallout by 2030.9)Retrieved 26 March 2018 https://www.independent.co.uk/news/business/analysis-and-features/brexit-divorce-bill-latest-deal-cost-impact-uk-how-big-eu-david-davis-juncker-barnier-a8082311.html
In the immediate aftermath of the divorce bill being announced, the GBP rallied 0.6% against the USD, reaching two month highs.10)Retrieved 26 March 2018 http://www.businessinsider.com/pound-price-movements-reports-brexit-divorce-bill-2017-11 The price action illustrated a common theme throughout the Brexit process: any elimination of uncertainty acted as a catalyst for gains in the pound sterling.
A Deal For Transition
On 19 March 2018, officials announced a deal governing the two-year implementation period following Britain’s scheduled exit from the EU. Led by chief negotiators Michel Barnier and David Davis, the deal put to rest many of the questions surrounding completion of the Brexit process.
The transition period, or implementation phase, is set to officially begin 29 March 2019 and last until 31 December 2020. This 21-month period is meant to provide affected industries and governmental agencies adequate time to make the necessary preparations for a smooth transition. Upon its completion, permanent guidelines for future EU/U.K. relations are to be put into place.
In addition, the agreement for implementation contains several key elements designed to promote a seamless transition for the U.K.’s exit:
- The U.K. will be able to unilaterally negotiate and ratify its own trade deals during this period.
- The U.K. will still be subject to existing E.U. trade deals until 31 December 2020.
- E.U. citizens immigrating to the U.K. will be given the same rights during the transition period.
- The U.K. will receive fishing rights, but will not be able to enact new fisheries policy until 31 December 2020.
- Northern Ireland will remain in the single market and customs union to avoid a “hard border” with the Republic of Ireland.11)Retrieved 27 March 2018 http://www.bbc.com/news/uk-politics-43456502
The deal for transition is a significant step in preserving long-term U.K./EU relations. While the issues of fishing rights and the Northern Ireland border are points of contention, a majority of the economic concerns over the Brexit transition are addressed thoroughly.
Upon news of the agreement being made public, the GBP rallied considerably against the USD and euro (EUR). In the trading session following the announcement, the GBP gained 0.7% against the euro and 0.9% vs the USD.12)Retrieved 27 March 2018 https://www.poundsterlinglive.com/gbp-live-today/8724-pound-to-euro-and-dollar-brexit-transitional-deal Citing an increased probability of tightening monetary policy from the Bank of England (BoE), several institutional investors raised long-term projections for the pound sterling. In turn, bullish sentiment toward the GBP crept into the marketplace.
Tumult And Surprise: Resignations Within The U.K. Brexit Transition Team
Amid tense negotiations, several leading proponents of Brexit abruptly resigned their positions on the U.K. transition team. Within a 24 hour period beginning 8 July 2018, Brexit Secretary David Davis and U.K. Foreign Minister Boris Johnson each took their leave of the process. In addition, Steve Baker, one of Davis’ deputy ministers, also tendered resignation. As a result, uncertainty grew facing the GBP and terms of the U.K. leaving the E.U.
One of the primary reasons for the departures was a disagreement with U.K. Prime Minister Theresa May regarding the extent of concessions to be made during ongoing negotiations. Citing terms outlined in the Chequers memo as being “too soft” toward the preservation of U.K. interests, both Johnson and Davis elected to tender their resignations. Several items outlined in the Chequers memo are credited with undermining Johnson and Davis’ desire to achieve a hard Brexit13)Retrieved 17 July 2018 https://www.lawfareblog.com/how-uk-government-resignations-signal-demise-hard-brexit:
- Creation of a combined customs territory between the E.U. and U.K.
- U.K. obligation to police the traffic of goods to the E.U. and apply E.U. tariffs where applicable.
- Both sides were to abide by a common rulebook for all goods flowing between the E.U. and U.K.
- Assorted matters were to be handled by a “joint institutional framework.”
In his resignation letter, Johnson referred to the Chequers memo as being a “semi-Brexit” and that it put the U.K. on a path to “colony status.”14)Retrieved 18 July 2018 https://twitter.com/BorisJohnson/status/1016373750395277313
The sudden resignations undermined the fluidity of the Brexit process and political stability of U.K. leadership. Subsequently, the chances of a Conservative party vote of “no confidence” facing Prime Minister Theresa May increased. Also, talk of a potential snap election for the Prime Minister seat also gained steam ahead of the March 2019 U.K. departure date.
The impact that each resignation had on the pound sterling was substantial. In the case of David Davis, the GBP experienced moderately positive volatility. In the hours after his stepping down became official, the GBP rallied 0.6% against the USD and 0.3% vs the Euro.15)Retrieved 18 July 2018 https://www.ft.com/content/fef0e51c-8300-11e8-96dd-fa565ec55929
Optimism toward the GBP proved fleeting as reports of Boris Johnson’s withdrawal flooded newswires hours later. Gains made in the wake of the Davis resignation were promptly given back, with the GBP falling 0.3% against the USD and Euro respectively.16)Retrieved 18 July 2018 https://www.bloomberg.com/news/articles/2018-07-09/pound-strengthens-as-u-k-government-crisis-is-seen-contained Due to the timing of Johnson’s abdication, the pound ended the forex session on a down note.
At their core, the departures of Davis and Johnson signalled upheaval on the U.K. side of the Brexit transition process. With the odds of a formal challenge to Theresa May’s leadership growing, the GBP experienced increased volatility due to the market’s perception of political risk. In fact, many currency analysts predicted a massive depreciation in the pound sterling in the event a turnover in leadership were to occur.17)Retrieved 18 July 2018 https://www.bloomberg.com/news/articles/2018-07-06/pound-investors-fear-currency-slide-if-may-leadership-challenged
While the Brexit process continued to move forward amid the shakeup in transition leadership, ambiguity regarding previously negotiated terms plagued the stability of the GBP.
As a general rule, markets are not fond of uncertainty. The 2016 vote in favour of Brexit created high levels of investor angst regarding the GBP, comparable only to the immediate aftermath of WWII or Black Wednesday. Subsequently, the transition process has been a rollercoaster ride for valuations of the pound sterling.
A brief summary of the forex price action facing the GBP amid the key events of the Brexit transition:
|Event||Gain Or Loss Versus The USD|
|Vote For Brexit||-10.0%|
|Article 50: Legal Challenge Upheld||+1.2%|
|Article 50: Parliament Votes “For”||-0.7%|
|Article 50: Invoked||-0.3%|
|Divorce Bill Announced||+0.6%|
|Transition Deal Announced||+0.9%|
While the events listed above certainly influenced the pound sterling’s pricing across the forex, the unexpected resignations of U.K. leadership did as well. The departures of Davis and Johnson intensified uncertainty regarding the prospects of a hard or soft Brexit. As a result, the GBP experienced significant short-term volatility as the U.K. dealt with surprise turnover in the Brexit transition team.
The initial shock of the Brexit vote was extreme. GBP valuations plummeted as the future of the U.K. came into question. As time passed and details surrounding the U.K.’s withdrawal were hammered out, many concerns began to fade. In the 18 months following the Brexit vote, the GBP/USD hit 1.4000, a 50% recovery of the Brexit crash. However, performance against the euro remained depressed, as values hovered near post-Brexit bottoms.18)Retrieved 27 March 2018 http://www.bbc.com/news/business-42794549
The U.K.’s future is a subject of debate among economists. The ability to craft its own trade deals amid a global economic resurgence is frequently cited as a potential driver of prosperity. Conversely, uncertainty pertaining to the fishing industry and possible Scottish independence are looked upon as negative factors that may hinder economic performance. Ultimately, only time will tell whether the U.K.’s economic growth and subsequent BoE policy will drive the value of the GBP higher.
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References [ + ]
|1, 2.||↑||Retrieved 23 March 2018 http://www.bbc.com/news/politics/eu_referendum/results|
|3.||↑||Retrieved 23 March 2018 http://www.businessinsider.com/the-pound-in-the-year-since-the-brexit-vote-2017-6|
|4.||↑||Retrieved 23 March 2018 http://www.lisbon-treaty.org/wcm/the-lisbon-treaty/treaty-on-european-union-and-comments/title-6-final-provisions/137-article-50.html|
|5.||↑||Retrieved 24 March 2018 http://www.businessinsider.com/the-pound-in-the-year-since-the-brexit-vote-2017-6#november-3-2016-9|
|6.||↑||Retrieved 25 March 2018 http://www.businessinsider.com/pound-price-movements-on-tuesday-march-14-2017-3|
|7.||↑||Retrieved 25 March 2018 https://www.marketwatch.com/story/british-pound-under-pressure-ahead-of-brexit-trigger-2017-03-29|
|8, 9.||↑||Retrieved 26 March 2018 https://www.independent.co.uk/news/business/analysis-and-features/brexit-divorce-bill-latest-deal-cost-impact-uk-how-big-eu-david-davis-juncker-barnier-a8082311.html|
|10.||↑||Retrieved 26 March 2018 http://www.businessinsider.com/pound-price-movements-reports-brexit-divorce-bill-2017-11|
|11.||↑||Retrieved 27 March 2018 http://www.bbc.com/news/uk-politics-43456502|
|12.||↑||Retrieved 27 March 2018 https://www.poundsterlinglive.com/gbp-live-today/8724-pound-to-euro-and-dollar-brexit-transitional-deal|
|13.||↑||Retrieved 17 July 2018 https://www.lawfareblog.com/how-uk-government-resignations-signal-demise-hard-brexit|
|14.||↑||Retrieved 18 July 2018 https://twitter.com/BorisJohnson/status/1016373750395277313|
|15.||↑||Retrieved 18 July 2018 https://www.ft.com/content/fef0e51c-8300-11e8-96dd-fa565ec55929|
|16.||↑||Retrieved 18 July 2018 https://www.bloomberg.com/news/articles/2018-07-09/pound-strengthens-as-u-k-government-crisis-is-seen-contained|
|17.||↑||Retrieved 18 July 2018 https://www.bloomberg.com/news/articles/2018-07-06/pound-investors-fear-currency-slide-if-may-leadership-challenged|
|18.||↑||Retrieved 27 March 2018 http://www.bbc.com/news/business-42794549|