The pound fell against the US dollar following the January Federal Reserve policy announcement, as the Fed warned that US interest rates could rise in March. Further rate rises by the Fed could also be announced and at a quicker pace, the Fed suggested. The pound has weakened against a strengthening US dollar.

Global risk sentiment was also weak due to concerns about a faster policy tightening by the Fed and political tensions between Russia and Ukraine. As a result, equity markets fell, which further pushed the dollar higher against the pound.  

Sterling was also undermined by the current political turmoil over UK Prime Minister Boris Johnson’s alleged lockdown parties in Downing Street. This has added more pressure on the GBP/USD pair, but expectations that the Bank of England will hike interest rates could help limit losses.

So far, the GBP/USD pair remains at the mercy of the US dollar dynamics, considering also that there are no relevant macroeconomic data coming out of the UK.

Fed announcement

Global markets are unnerved today after the US central bank signalled it is ready to raise interest rates. Federal Reserve chair Jerome Powell was hawkish in tone at last night’s press conference and said that the Fed was ready to raise interest rates in March. He also noted that an aggressive cycle of interest rate rises at coming meetings was also possible.

Powell told reporters there was “quite a bit of room to raise interest rates without threatening the labor market.” He warned that inflation was higher than the Fed’s target while supply chain issues pose considerable risks if they continue to persist.

Investors are now expecting a sharp rise in interest rates this year, after Powell suggested that the Fed could tighten policy faster than expected.

The Fed reaffirmed market expectations for a rate hike in March, which pushed US Treasury bond yields higher. The 2-year US bond yield rose and pushed the USD to the highest level since mid-December.

Pound to strengthen

Financial analysts have noted that the uncertainty around Prime Minister Boris Johnson will unlikely not persist. Additionally, with more positive economic data and Covid restrictions easing, the pound should go higher.

Economists at Westpac said: “The easing of covid restrictions and moves away from working from home should lift economic activity. Nov employment and production were stronger than anticipated and inflation data was notably higher. Dec’s Omicron impacted retail sales were surprisingly weak, but recent survey data suggest that demand has remained firm and maintain potential for another BoE hike.”

In relation to PM Johnson’s position, they pointed out that although there is discontent and calls for him to resign, 15% (54 MPs) of Tory MPs still need to express their lack of confidence to trigger a leadership challenge. While there may be challenges to his leadership, this may be positive as it will end uncertainty and support the pound.  

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The pound has risen very slightly on Friday (14/01/2022), despite better-than-expected UK data.

UK GDP for November

GDP rose 0.9% m/m in November, above the forecast of 0.4%, while Manufacturing Production jumped 1.1% m/m, surpassing the expected 0.2%. Both figures were higher than the October releases and demonstrate that the UK economy continues its recovery. GDP for Q4 is expected to reach or go beyond the pre-pandemic level (Q4 2019), eliminating any possibility for disappointment for the December GDP report.

The Gross Domestic Product released by the National Statistics measures the total value of all goods and services produced by the UK. It is considered as a comprehensive measure of UK economic activity and as such, if it rises, this has a positive effect on the GBP, while, if it falls, then this is seen as negative for the British currency.

Despite the good news, business groups have warned that the economy remained weak, as inflation has continued to rise, and the Bank of England could further raise interest rates. Suren Thiru, the head of economics at the British Chambers of Commerce, said: “Stronger growth in November is likely to be followed by a modest fall in output in December and January, as consumer caution to socialise and spend, and mounting staff absences sparked by Omicron and plan B limit activity. While the UK economy should rebound once plan B measures are lifted, surging inflation and persistent supply chain disruption may mean that the UK’s economic growth prospects remain under pressure for much of 2022.”

While analysts anticipate stronger growth in 2022, consumer spending will be limited due to the rising cost of living. Wages are expected to go up around 3.5% in 2022, as prices rise.

The chancellor, Rishi Sunak, congratulated the “grit and determination of the British people” and noted how “amazing” it was to see the economy back to pre-pandemic levels in November. He said: “The government is continuing to support the economy, including through grants, loans and tax reliefs for businesses, and our plan for jobs is ensuring people up and down the country have fantastic opportunities. We all have a vital part to play to protect lives and jobs, and I urge everyone to do theirs by getting boosted as soon as you can.”

Johnson under criticism

Prime Minister Boris Johnson is under criticism after revelations that his staff held parties during the Covid lockdown. Boris Johnson is already facing calls to resign from the opposition and some senior Tories after he admitted attending a drinks’ gathering in May 2020. According to the latest news, Downing Street staff held two parties during Covid restrictions with both taking place the night before Prince Philip's funeral. The Telegraph reported that the events took place on 16 April 2021 and continued past midnight. Prime Minister Boris Johnson was not at either party, but the events raise questions about the culture at No 10, Labour's deputy leader Rayner said.

Johnson has urged MPs to wait for the outcome of an investigation into lockdown gatherings by senior civil servant Sue Gray, which is expected next week.

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UK Prime Minister Boris Johnson has come under scrutiny after he admitted attending a drinks party in lockdown. The British Pound has proven resilient and did not fall following calls to resign.

The pound rose to its highest level against the US dollar and is close to two-year highs against the euro despite signs that members of the Conservative party are dissatisfied with the Prime Minister. This raises the chances of Boris Johnson being replaced as a leader in 2022.

Traditionally, the pound has come under pressure during periods of political instability, uncertainty or anxiety, such as the Brexit referendum, but the current developments have not impacted the pound. Sterling ignored political risks and reached two-month highs against the US dollar, proving that the markets are not convinced that Johnson will resign.

Controversy over the Downing Street party

Johnson has denied breaking any rules regarding the May 2020 gathering in the Downing Street garden. The Northern Ireland secretary, Brandon Lewis, has noted that the prime minister was “very, very sincere” when he apologised for attending what he thought was a “work event” and what his principal private secretary had called “socially distanced drinks.” Lewis told Sky news that the PM doesn’t believe that he has done anything outside the rules. “If you look at what the investigation finds, people will be able to take their own view of that at the time,” he added.

Johnson’s apology has not soothed the concerns of many Conservatives, with some of them including the Scottish Tory leader, Douglas Ross, and the senior backbencher William Wragg calling for him to resign. A number of other cabinet ministers were slow to express their support for Johnson.

Some MPs suggested Johnson was unremorseful when talking to colleagues after his apology at the House of Commons. Talking to BBC Radio 4’s Today programme, Lewis clarified that the PM regretted doing what he did and that he did “recognise the anger and upset and frustration that people feel at what they perceive happened at No 10.”

Sterling remains one of the best performing G10 currencies*

Despite the political controversy surrounding PM Johnson, the pound remains at the top of G10 currencies for the month.  Analysts have also underlined that the political risks are not threatening in any way as a UK election is not scheduled until 2024.

While this might be the most difficult period of Boris Johnson’s tenure, markets are not concerned and not willing to price in any political risks. Additionally, markets do not appear to be threatened by a new PM in the form of Rishi Sunak or Liz Truss who are the favourites among Conservative members. Both The Times and The Telegraph have published headlines pointing that Rishi Sunak is believed to have what it takes to be the next PM. The situation is also different than the election period of 2019, as there are no Brexit risks. The next PM is not expected to call a snap election and the government’s majority will remain intact.

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* G10 currencies are the most important currencies traded in the currency market and the most widely used within the financial markets. These include the US dollar, euro, British pound, Japanese yen, Australian dollar, New Zealand dollar, Canadian dollar Swedish krona, Norwegian krone, and the Swiss franc.

 

A potential break down in relationships between the UK and EU could risk affecting economic recovery and hurt the pound. The possible decision of Britain to suspend the Northern Ireland part of the Brexit deal could weigh on the pound. According to Bloomberg, “The UK warned the European Union not to start a trade war if Boris Johnson’s government suspends part of the Brexit settlement over Northern Ireland, saying a strong retaliation would exacerbate problems.” Additional concerns such as Covid and supply chain issues that could deter the Bank of England from raising interest rates may also affect the British currency.

Boris Johnson to avoid a confrontation with Brussels

Boris Johnson does not want a confrontation with Brussels. The UK is already dealing with enough problems including increasing costs of living, rising inflation and energy prices.

As the Financial Times noted, the PM wants to avoid a trade war with the EU and have a quiet Christmas following last year’s cancellation of Christmas festivities due to Covid.

In last week’s Global Britain (Strategy) committee meeting to discuss Brexit concerns, senior cabinet ministers analysed the political tensions between Britain and the EU and the dispute over trade in Northern Ireland.

Rishi Sunak, chancellor of the exchequer, warned that entering a trade dispute in regard to the Northern Ireland protocol would create problems, especially as Christmas is coming up.  To avoid any confrontation with Brussels, Johnson asked chief negotiator Lord David Frost to return to discussions with Brussels and try to resolve the dispute over Northern Ireland.

The shift in tone is intended to provide the necessary space so that negotiators can try to resolve the Northern Ireland dispute and to start repairing UK-EU relations.

Brexit is already affecting Britain economically. The Office for Budget Responsibility said last month that Brexit’s long-term effects on the British economy will be twice that of the Covid pandemic. The OBR believes that total UK imports and exports would “eventually be 15 per cent lower than had we stayed in the EU”.

Pound to rise further, analyst argues

Despite above risks, the recent gains of the pound due to higher inflation data and a strong jobs report appear to further lend support to hedge fund analyst Savvas Savouri’s argument that the pound will post more gains. Savouri believes that the pound will rise further due to the economic backdrop, potential higher interest rates and increased demand for the pound from China.

According to Pound Sterling Live, Savouri said that "Sterling is poised to gap-up impressively for several reasons, including the strong UK economic backdrop, a sensible and sustained rise in the bank rate, and a potentially larger weighting in the currency basket of the People’s Bank of China.”

Because of Brexit, Savouri says the pound continues to be valued much lower and is cheap according to his view. Savouri has argued that the pound will do what it did back in 1996: “after four years of weakness following its shock ERM exit in September 1992, the pound gaped-up impressively."

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Sterling climbed against the dollar on Monday after the EU and UK announced that they will “go the extra mile” and continue with Brexit negotiations. 

After last week, when the pound fell due to concerns over a no-deal Brexit, this week the pound rose reversing some of its losses. The Prime Minister Boris Johnson and European Commission president Ursula von der Leyen agreed during a “constructive” call on Sunday to “go the extra mile” in order to secure a trade deal for the UK. With no deadline for negotiations, British officials have said that negotiations could continue until Christmas. 

What do analysts say?

Whatever happens to the pound is going to have an impact on Thursday’s Bank of England meeting which is expected to remain on hold. Analysts believe that if markets are worried and the pound falls on the prospect of a no deal, then the BoE might increase its QE purchases within a short period of time. Nonetheless, pound volatility as we near the end of 2020 is to be expected. 

Goldman Sachs has predicted that the pound will rise if there is progress towards a deal or a no-deal Brexit is avoided. Barclays analysts explained that there will be risks to the pound until an agreement is reached. As the Financial Times reported, some analysts have changed their mind, quoting Gregory Perdon, co-chief investment officer at Arbuthnot Latham, who had “second thoughts” about the pound rising, but he reiterated his hopes for a deal as  “both parties are probably better off economically with a deal.” “Let’s hope rationality wins in this instance,” he added. 

Others more pessimistic, have warned that the pound’s gains might be short-lived, as both the UK and EU have failed to reach a deal repeatedly in the past.

Talking to Reuters, Junichi Ishikawa, senior foreign exchange strategist at IG Securities said: “This is a temporary move higher in the pound, but it is still not clear that a no-deal scenario can be avoided.”

Whether there is a deal or no deal, some investors feel that the pound could still move sharply.

What’s next?

The UK left the European Union on 31 January 2020, but the ongoing negotiations between the UK and EU officials are focussing on securing and negotiating a deal about the rules that will determine and define the kind of relationship the two parties will have post-Brexit. Michel Barnier has commented that Boris Johnson has made a mistake for hoping to negotiate an agreement within only 11 months.

The two sides have until 31 December 2020 to agree a trade deal and, if there is a deal, border checks and taxes will be introduced. The transition period ends on 31 December, and tariffs and quotas will be introduced in the event of a no deal.

A joint UK-EU statement stated that “despite the fact that deadlines have been missed over and over we think it is responsible at this point to go the extra mile."

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Sterling rose after renewed hopes that a Brexit deal is still possible, as the UK Prime Minister Boris Johnson is heading to Brussels for a meeting with the President of the European Commission, Ursula von der Leyen. Heightened volatility is expected as the meeting could take place any time this week or over the weekend, with any rumours possibly to move the currency.

On Monday, the GBP suffered losses after news that the negotiations reached a stalemate, and the PM stated that he was willing to walk away. But, later, on Monday, as it was announced that Johnson would be travelling to Brussels for a face-to-face meeting with von der Leyen, the pound regained some of its losses. News about the meeting is not yet clear and markets expect the two to either meet on Wednesday or possibly Friday. On Thursday, a meeting of European Council EU leaders will also take place, and many predict that the meeting with von der Leyen could even take place in the weekend, to allow EU leaders to approve of a new mandate for the EU Commission President before the meeting.

With confidence dwindling and the possibility of a deal becoming more and more distant, markets will remain sensitive to any Brexit updates. While everyone was expecting Johnson and von der Leyen to discuss over the phone, the announcement of a physical meeting caught markets by surprise. At the current moment everyone hopes that a breakthrough could be reached by an intensification of negotiations at a more personal and political level.

What to expect for Sterling in 2021?

A lot depends on a positive Brexit outcome. The currency is also correlated with global business and economy, so any general positive upswings will also boost the pound. According to economists at Oxford Economics, global economy will expand and the UK will benefit from the trend, especially after being so badly impacted by the pandemic.

However, if both sides fail to reach an agreement, the Pound could fall below parity, as many believe there is much more downside risk than upside. There is a real risk to the outlook of the UK economy and the pound if a no deal outcome ensues, but, at the same time, there are multiple scenarios possible: a deal or no deal, as well as a so-called cooperative no deal and an uncooperative no deal. An uncooperative no-deal Brexit will be more disruptive than a cooperative no-deal Brexit, in which the EU and the UK will be able to cooperate on a number of pressing emergency issues.

The UK government announced on Monday 7th Dec. that they will remove those elements that the EU openly disagrees with in the possibility of a trade deal, including the law-breaking clauses of the Brexit Bill. However, the clauses might return if a trade deal is not agreed, which will point towards a hard, uncooperative no deal Brexit. In this scenario, the pound will fall to the lower end.

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The possibility of striking a Brexit deal before the weekend has helped to stabilise the pound as it recovered some ground, on Thursday. However, tensions are building ahead of the weekend as talks continue. This means that any Brexit-related headlines will create pound volatility and move the market considerably.

The clock is ticking

While markets are hopeful that a deal will be reached, the fact that the clock is now ticking with little space for manoeuvres means that the pound will remain sensitive. The Telegraph reported that Barnier told EU ambassadors that the UK has become more flexible and lowered its demands in regard to UK waters post-Brexit, demonstrating that the two sides are closer to an agreement. Fisheries and governance remain unresolved, with the latter to be negotiated once all other agreements are settled. Talks could now focus on the percentages involved in fisheries, but France might prove to be uncompromising on its fishing demands. According to The Telegraph, "Fishing nations such as France, Denmark, the Netherlands, Belgium and Spain fear Mr Barnier may cave too easily to British demands as talks enter their endgame. Paris insists the UK red line of annual fishing negotiations is unacceptable.” France has already clarified that it will veto any deal that goes against their interests.

A report in The Times said that "France and other hard-line countries are pushing for no deal in Brexit talks to soften up Britain before a reset in negotiations next year, unless the government makes significant concessions in the coming days," and unless the UK "backs down over the next 48 hours", a period of 'no deal' will "bring a chastened Britain back to the table next year".

The BBC's Europe Editor Katya Adler said that Brussels believe a deal will be possible in the event that the UK makes significant steps to meet the demands regarding fisheries, competition rules and governance.

Talks continue in London

Negotiations are at the final stages, but it appears that any last hurdles will require, maybe not divine intervention, but at least some help from leaders from the UK, EU Commission and France. Both Wednesday and Thursday, saw negotiators working well into the night for the final push.

On Friday, The Telegraph reported that talks will find Boris Johnson and Emmanuel Macron coming head to head this weekend, with France interested in securing access to fish in British waters.

According to certain sources, Macron's officials have been "lobbying hard" among different member states to agree to added demands on fishing, state subsidies and non-regression clauses, and these will be discussed by both the PM and the French president over the weekend.

EU member states could also veto any deal as they continue to have concerns about state aid mechanisms and how to enforce agreed environmental and labour standards. France and Denmark are reluctant to lose their fishing shares in UK waters.

Indeed, there is not much time left now, as negotiations continue and the upcoming EU leaders’ meeting on 10 and 11 December 10-11 means that a final deal needs to be ready to be agreed. Sterling will make significant gains if a deal is announced in the coming weeks and it could potentially continue to rise.

 

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Sterling extended earlier gains after a report that the UK and the European Union could agree on a trade and security deal some time next week. Optimism regarding striking an agreement has given the pound fresh impetus, despite that time is running out.

Economists believe that Sterling could strengthen more by mid-2021 if a free trade agreement is reached, as officials are expecting news of some form of progress as early as Monday. British and European parliaments will still need to confirm the terms of the agreement before the transition period ends on 31 December. At the moment, investors remain hopeful, but the possibility of the talks stalling as major differences cannot be bridged is strong, and in such a scenario the pound would likely fall.

Newspaper reports suggest a trade deal is possible

During the week, various newspaper reports have suggested that a trade deal is "just days away" with the Telegraph saying that Ireland believes there are "landing zones" for an agreement and that France has accepted the restrictions to its fishing rights in UK waters after the transition period ends. The newspaper also reported that "the trade agreement could be announced as early as Monday, sources in Brussels suggested – but only if both sides made compromises on issues such as fishing and subsidy law." On Tuesday, the Sun newspaper said a deal could be expected next Tuesday, as the UK Chief Negotiator David Frost said to the Prime Minister Boris Johnson to prepare for a trade deal on Tuesday, news that have helped lift the pound.

Despite positive but unofficial reports in British newspapers, both the EU and UK have not offered a definite answer about the status of the negotiations which means the possibility of a no deal is still a valid outcome with some analysts remaining very cautious. At the same time, the markets seem to have made peace with a possible no-deal scenario, so any news of a deal, no matter what that deal is, will lift the pound. However, a possible deal will only mean temporary and limited gains for the pound according to some analysts, while for others, a considerable rise should be expected.

Brexiteers feel stuck as no deal impossible

The UK is now trapped and will be unable to benefit from Brexit, said former Brexit Party MEP Ben Habib. Habib, who attacked the PM saying that a no deal Brexit was not possible, said in an interview to Express.co.uk, that "We are already stuck, to some extent, in the gravitational pull of the European Union.” For hard Brexiteer Habib, a no deal Brexit would allow the UK to completely cut its ties to the European Union, but, unfortunately, this is not possible anymore. As he said, "We have a deal of some description from which we simply cannot escape."

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Pound volatility is expected to be high today and on Monday as the markets await Prime Minister Boris Johnson’s decision on whether the UK stays or leaves the Brexit negotiating table.

In the meantime, England is dealing with the rise of new Covid-19 cases and restrictions which will come into force under the government’s new three-tier system with London facing tighter restrictions from midnight on Friday.

Under this generalised gloomy climate, investors are waiting to hear whether the UK will continue with the Brexit talks. Last month, Johnson had set a deadline for a possible deal for the 15th October, and said that if nothing had been agreed, both sides should “accept that and move on.”

At a Brussels summit on Thursday, the EU proposed “two to three weeks” of negotiations. Investors are now closely watching to see whether the PM will try and resume the negotiations or stick to his threats and walk away.

Brexit pessimism pushed the pound lower against the US dollar, while it remained flat against the euro. At the same time, the prospect of tighter lockdown restrictions could further hurt the pound and threaten economic recovery. Jasper Lawler, head of research at LCG, said that more lockdown measures could push the UK and European economies into a deep recession: “The British government is under pressure to follow scientific advice for a 2-week circuit breaker national lockdown but has so far resisted, but has raised the capital to the Level 2 tier of restrictions. That means two different families can no longer mix indoors- be that in their home or in a pub or restaurant. There is still no sign of the joint European recovery fund so in the meantime economies stand to take the hit – risking a double dip recession – from the new restrictions.”

Angela Merkel urges Boris Johnson to keep negotiating over Brexit

The German chancellor has urged Boris Johnson to continue and not to walk out of the trade and security negotiations. In her comments that were designed to calm the atmosphere, Merkel said that both sides needed to find common ground: “In some places things have moved well, in other places there is still a lot of work to be done. We have asked the United Kingdom to remain open to compromise, so that an agreement can be reached. This of course means that we, too, will need to make compromises.” Her comments also come after Thursday’s summit where French president, Emmanuel Macron, demanded that the UK accept the bloc’s conditions or face a no-deal exit.

The EU had proposed a further “two to three weeks” of negotiations as the EU’s chief negotiator, Michel Barnier is scheduled to be in London on Monday to continue negotiations. Like Merkel, Barnier also said that the EU wants to give every chance to the negotiations so they are successful: “We’re available, we shall remain available until the last possible day.”

The UK’s chief negotiator, David Frost, expressed his disappointment after Thursday’s summit and tweeted: “Disappointed by the conclusions on UK/EU negotiations. Surprised EU is no longer committed to working ‘intensively’ to reach a future partnership as agreed with [the European commission president, Ursula von der Leyen] on 3 October. Also surprised by suggestion that to get an agreement all future moves must come from UK. It’s an unusual approach to conducting a negotiation.”

The foreign secretary, Dominic Raab, said that a deal was still possible: “We’ve been told that it must be the UK that makes all of the compromises in the days ahead, that can’t be right in a negotiation, so we’re surprised by that, but the prime minister will be saying more on this later today. Having said that, we are close [to a deal]. With goodwill on both sides we can get there.”

While challenges remain when it comes to the Brexit negotiations with the level playing field, fisheries, and governance, still unresolved, many are positive that there could be an agreement if significant work is done.

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The British Pound pushed higher after investor sentiment improved due to the positive news that a deal between EU leaders have been reached. The euro also rose higher. The deal includes €1.8tn in spending, with a €750bn rescue fund to deal with the coronavirus pandemic. €390bn out of the €750bn will be made in grants.

Brexit trade negotiations a key driver for the pound

However, Sterling continues to remain under pressure as Brexit developments can thwart sentiment, while any updates from the Bank of England in relation to negative interest rates can also create further concerns.

Brexit negotiations will take place from Tuesday to Thursday and will cover such issues as trade in goods, fisheries, energy, transport and participation in certain EU programmes. The round will end with a plenary session on Thursday. The Brexit chief negotiator Michel Barnier will hold a press conference and investors will be watching to see any signs of progress regarding the latest round of EU-UK trade negotiations which will significantly boost Sterling.

Brexit trade deal and Tory rebellion

Boris Johnson faces a rebellion from Tories who want to pass an amendment to the Trade Bill that will allow the House of Commons and House of Lords to vote for a trade deal agreed between the UK and any other country.

After Brexit, the UK will need to renegotiate trade deals, something that has been celebrated by Brexiteers and criticised by Remainers. For many, such trade deals with countries like the US will sacrifice certain standards that were followed while the UK was under European legislation. After leaving the European Union at the end of this year, Britain will need to be extremely cautious when striking new deals that will be beneficial to its people rather than meeting the demands of political agendas. The government’s reluctance to allow its lawmakers and the people’s representatives to have a say in the negotiations, goes against its own promise of taking back control from Europe and giving it back to the UK people. Additionally, it denies any scrutiny and seeks to pass deals without a dialogue, enforcing laws that could have repercussions on the social and political lives of its citizens for years to come.

Post-Brexit trade talks on a standstill

EU officers have complained that trade talks have been “going round in circles”, and Downing Street said that “significant differences remain on a number of important issues.” This is what is also expected to be reiterated on Thursday when Barnier appears at the press conference, as both sides are anticipating a stalemate.

Another round of talks will begin the week of August 17, but Germany said that it won’t begin to focus on the negotiations until September.

Boris Johnson does not want talks to “drag on into the autumn”, but he will need to make some concessions to see any movement forward. “We’re waiting for the UK to move,” an EU official has said according to the Financial Times. Johnson has talked of trading with the EU like Australia, but he would need to secure a trade deal that will eventually confirm his competency as a Prime Minister and avoid a disorderly Brexit that could lead to calls for Scottish Independence.

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