In worrying times like this, it is important for us to point out that we completely acknowledge the wider implications of international conflict. Our principle duty as a company is to ensure that our clients are aware of all of the factors that affect currency exchange rates, which sadly sometimes includes war. Our thoughts are with everyone who is being affected by this escalating situation, and our currency updates do not intend to diminish, ignore or undermine the true impacts of this conflict.

If the Ukraine conflict escalates, the pound will remain under pressure, economists at MUFG Bank said. The upcoming Federal Reserve (Fed) and Bank of England (BoE) monetary policy decisions could push the pound against the US dollar lower in the coming days, some analysts have warned.

On Monday, during early trading hours, European stock markets rose on hopes that peace talks between Russia and Ukraine could make progress. The GBP/USD pair also recovered from its daily low and climbed higher as risk sentiment recovered, pushing the safe-haven US dollar lower. Both sides have shown cautious optimism ahead of Monday’s negotiations, with a Russian delegate yesterday saying that there has been “substantial progress.” However, it is not clear how Russian president Vladimir Putin’s position has changed, since yesterday an attack on a major military base close to Poland’s border killed at least 35 people.

According to the Ukrainian general prosecutor’s office, ninety children have been killed and more than 100 wounded since Russia invaded Ukraine on 24 February. The highest number of victims are in the Kyiv, Kharkiv, Donetsk, Chernihiv, Sumy, Kherson, Mykolayiv and Zhytomyr regions, the statement said. Russia denies targeting civilians and has called the war a “special operation” to demilitarise and “de-nazify” Ukraine.

UK support for Ukraine

The British health secretary Sajid Javid said the Ukraine family scheme for refugees was “being made easier and more straightforward” from Tuesday. Talking to Times Radio, he said that “just over 3,000” visas had been granted through the programme. Javid said: “As well as that particular scheme, the extended family scheme being made easier and more straightforward by our online-only process from tomorrow, there’s the new homes for Ukrainian families scheme, which will also go live later this week.”

According to the government’s announcement on Sunday, as reported by Reuters, those who can offer a living space for refugees for at least six months could receive £350 a month. The "Homes for Ukraine" programme will have a website where individuals and organisations will be able to register by the end of next week. Those who offer a room or home for refugees will have to pass a criminal background check and show that their home meets required standards.

Central Banks

On Wednesday, we have the FOMC’s policy decision and on Thursday, the Bank of England’s decision. Both central banks are expected to increase their interest rate by 25bp. The market reaction will depend on their post-meeting statements and how optimistic or pessimistic the two banks are about the economic outlook.

Fed Chairman Jerome Powell pointed out that this Wednesday the Fed will possibly lift its interest rate from 0.25% to 0.5%, although financial markets expect a larger increase to 0.75%.

The BoE is widely expected to raise the Bank Rate from 0.5% to 0.75% on Thursday and 2% by year-end. BoE Governor Andrew Bailey had warned markets, even before the war in Ukraine, “not to get carried away” with their interest rate expectations. A cautious statement would push the pound lower, especially because the Fed is expected to deliver a hawkish decision on Wednesday.

Analysts believe that the GBPUSD and EURGBP will be sensitive to any important changes to the outlook for BoE rate hikes. Markets are currently pricing more than 5 hikes over the coming 6 months.

In the meantime, any new developments surrounding the Russia-Ukraine conflict will influence market risk sentiment.

 

The pound strengthened for a second successive day against a weaker US dollar as the positive risk mood weighed on the greenback. The release of stronger UK CPI offered support to the British pound.

The pound strengthened following Tuesday's stronger UK wage growth figures and better than expected UK consumer inflation data released this Wednesday. The headline UK CPI reached to 5.5% YoY rate in January while the core CPI, which excludes food and energy prices, rose to 4.4% YoY from. The positive releases have reinforced the case for additional monetary policy tightening by the Bank of England.

Any potential tensions over the Northern Ireland Protocol could limit further gains for the pound while the possibility of a 50 bps Fed rate hike in March should limit USD losses. For the US dollar, the main driver for Wednesday will be the FOMC meeting minutes.

UK Inflation data

UK inflation has hit a new 30-year high, which means that households will be burdened with the cost-of-living squeeze. Data released on Wednesday by the Office for National Statistics revealed that consumer prices rose by 5.5% in the 12 months to January, which marks the highest reading since March 1992 and is above the Bank of England’s 2% inflation target. Higher energy costs and transport costs helped to push inflation higher.

Chancellor of the Exchequer, Rishi Sunak, has responded to the inflation data by recognising the pressures that people will face as the cost of living rises. He said that “These are global challenges, but we have listened to people’s concerns and recently stepped in to provide millions of households with up to £350 to help with rising energy bills. We’re also helping people on the lowest incomes keep more of what they earn by cutting the Universal Credit taper rate, and freezing alcohol and fuel duties to keep costs down. In total we’re providing support with the cost of living worth over £20bn across this financial year and next.”

Prices for goods

The ONS said that various goods prices’ including those for clothing and footwear, housing and household services and furniture and household goods pushed up inflation in January. Electricity prices rose by 19.2% over the last year, while gas prices rose 28.3%. The squeeze will be felt even more this spring, when the energy price cap is lifted by 54%, and national insurance contributions rise. Furniture and household goods’ prices rose by 8.5% over the year, the highest since January 1989.

Interest rates to rise

Economists believe that interest rates will rise further, as inflation reaches 7.9% in April, adding more pressure on households. Ed Monk, associate director at Fidelity International, explained: “The pace of price rises has put the Bank of England on a much more hawkish footing and a third month in a row of interest rates rises now looks likely in March. That will, of course, squeeze borrowers even more and will add headwinds for the UK economy which has only recently managed to regain the ground lost to the pandemic.”

 

The Bank of England warned this month that consumer price inflation could reach at around 7.25% by April as increasing energy prices reach consumers.

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Sterling strengthened following higher than expected inflation numbers. UK inflation jumped to a near-30-year high of 5.4% and economists have noted that inflation will continue to rise.

Inflation is anticipated to exceed 6% in April and come closer to 7% as supply chain issues come to feed through into prices in the shops and domestic energy bills rise up to 50%. The data which was released by the Office for National Statistics will also affect the Bank of England’s decisions, as the Bank is required to keep inflation close to the government’s 2% inflation target and has continually underestimated the recent price pressures. Traders and investors will closely watch the Bank’s meeting in early February, as expectations for an increase in borrowing costs from 0.25% to 0.5% have now increased.

Inflation

UK CPI inflation for December came at 5.4% year-on-year according to the ONS, beating expectations of a 5.2% reading and surpassing November's number of 5.1%. Core CPI inflation was at 4.2%, higher than the market’s expectation for 3.9%. CPI is now above the Bank of England’s target and the highest since the UK first adopted an inflation target in October 1992. According to the ONS, December's strong inflation numbers were boosted by higher prices in transport, food and non-alcoholic beverages, furniture and household goods, and housing and household services.

Bank of England and interest rate hike

The Bank of England raised rates in December as inflation in the UK rose above the 2.0% target and now markets anticipate another rate rise in February. Markets expect the Bank Rate to reach 1.25% by the end of 2022.

Some analysts believe the pound has further potential to rise following strong employment levels and higher inflation, while others believe that it has reached its highest level.

Inflation to rise further

Economists expect inflation to rise more and to peak in the months ahead, as the energy price cap is raised. With prices on the rise and real wages already falling, households will struggle with the cost of living.

Chancellor Rishi Sunak commenting on today’s data said: "I understand the pressures people are facing with the cost of living, and we will continue to listen to people's concerns."

The government has been urged to find solutions to protect those consumers who will struggle the most as prices continue to rise. The CBI has also called the government to provide support to struggling firms, especially energy-intensive businesses. In the coming months, the release of more data may reflect higher costs being passed from firms over to consumers as they try to maintain their company margins. Higher energy prices and tax rises will contribute to the looming cost of living squeeze. The TUC, which includes 48 member unions, has also called the government to come up with a plan to deal with the UK’s cost of living crisis. TUC general Secretary Frances O’Grady said that families are facing higher inflation pressures and slowing wage growth and need more help from the government.

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Despite Omicron concerns, the pound has hit its highest level against the US dollar since November and its highest level against the euro since February 2020.

Bank of England rate hike

The expectation of inflation rising has helped to push the pound higher as traders now anticipate the Bank of England to hike interest rates in February, after raising them to 0.25% in December. Economists believe that it’s a close call as Omicron is expected to hit economic growth this winter. The economic impact of Omicron might not be huge or long-lasting, but the Bank still needs to tread carefully. While the markets expect the Bank of England to hike rates again at the start of February, some analysts think it might wait a little bit more, until May.

Businesses are facing staff shortages while consumer spending has been much lower in the end of December. Analysts believe that the Bank might wait for more data, and as such a rate hike in May appears to be more likely.

UK Covid cases have peaked

It is beginning to look quite hopeful experts have said, as there are hopes that the UK Covid cases have peaked in all parts of England. New case numbers are starting to fall in the South East and the East of England, and in London. According to official records, as of January 8, new case numbers are beginning to fall in the South East and the East of England, as well as in London, which peaked before Christmas. Cases are rising in other regions but at a much lower pace.

Professor Kevin Fenton, Public Health England’s regional director for London, told the Sky News that the Omicron wave has now peaked in London. He warned that ONS data showed that almost one in 10 Londoners are still infected with the virus and the pandemic is not yet over.

While case numbers and hospitalisations are dropping, scientists have highlighted the significance of vaccines which are believed to have prevented intensive care wards, and the NHS, from being overwhelmed.

The Prime Minister confirmed that ministers are considering reducing the self-isolation period for fully vaccinated people who test positive for the virus to five days from the current seven.

The prospect of a drop in cases suggests that an economic rebound into the second half of Q1 is possible and this in turn will validate the prospect of a February interest rate hike.

Economists have noted that the most negative economic impact of Omicron is the rising number of self-isolation cases and weak consumer sentiment. The combination of the two could further slowdown economic activity.

If there is an economic rebound, then the Bank is expected to raise interest rates and markets are pricing more than a 70% chance of another UK rate rise next month. The rise of US and UK bond yields has also offered support to the pound so far. Sterling remains the best performing G10 currency of 2022.

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The pound was resilient against the US dollar and has risen to two-month highs. Last week it hit a 22-month high against the euro as the potential for more hikes by the Bank of England (BoE) offered support. Omicron concerns have eaten away at some of the pound’s gains against the euro.

The prospect of a BoE interest rate hike at the Bank’s February meeting has helped boost market expectations.

UK Prime Minister looking to reduce quarantine period

British Prime Minister Boris Johnson said on Monday that the government is considering the prospect of reducing the quarantine period from seven to five days. Since Britain was making progress against the variant, the government will look at reducing the days of isolation, but it warned that the number of hospitalised people was rising. The Prime Minister explained that "We've got to make sure that we see off Omicron. We're making great progress. (But) the 18,000 people with COVID currently in hospital... that's massively up, and the numbers are increasing.”

His comments did not have a noticeable impact on the pound.

UK companies remain optimistic

The latest survey from accountancy company Deloitte has showed that 37% of chief financial officers are planning to boost investment in 2022 and focus on growth despite Omicron concerns. Companies expect conditions and productivity to improve but persistent labour shortages remain a considerable risk. A high number of companies believe that trade conditions have been affected by Brexit.         

Brexit concerns

Manufacturers have warned that Brexit will exacerbate costs amid concerns of persistent challenges relating to customs delays and red tape. Make UK, which represents 20,000 manufacturing firms across the UK has said that Brexit remains a central concern. In its 2022 Make UK/PwC senior executive survey of 228 firms, businesses have warned of damage from Brexit disruption which has been further complicated by the pandemic and rising costs.

GBP/EUR hits a 22-month high

Last week’s positive market sentiment favoured risk sensitive currencies such as the pound and pushed the euro lower. The euro was also lower due to the significant differences in policies by the UK and European central banks. Eurozone data did not help offer any support.

The pound rose further following the UK government’s decision not to introduce more Covid restrictions while BoE rate hike expectations boosted Sterling. Traders have now priced in an 82.5% chance of another interest rate rise at the bank’s meeting in February.

However, the rising number of Covid cases puts further pressure on the pound which has failed to sustain its 22-month high.

Week ahead: What to expect

Omicron will continue to impact on the British currency. If Covid cases continue to fall, then the pound will strengthen and vice versa.  

On Friday, we get the latest GDP data, which is expected to have grown 0.4% in November and may help offer support to the pound.

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The pound started the new year strong as it rose against the US dollar on Tuesday and Wednesday. Analysts say that the strengthening is due to investor optimism about the effects of the Omicron variant of Covid-19 which has been less disruptive to the economy than originally expected. Investors are also optimistic about a potential Bank of England interest rate rise as early as next month.

On Thursday, the pound was lower as the US dollar strengthened following the Fed meeting minutes which showed that the Bank was more hawkish than expected. These has created concerns about faster than expected tightening of the Fed’s monetary policy which along with rising inflation will require the Bank to act and raise rates sooner than expected.

Services PMI data was higher than the preliminary reading, but it showed that the UK services sector lost momentum last month due to the lockdown, with the hospitality and travel sectors being affected the most.

Omicron restrictions ease

While the Omicron variant has affected a high number of UK citizens, the Prime Minister Boris Johnson avoided stricter lockdown measures and on Wednesday he announced that a pre-departure test was not needed when travelling to England.

Markets also appear to have decided that Omicron concerns are over, and investors are now focussing on the prospect of wider global reflation. Reflation refers to attempts to bring the economy back up to the long-term trend following a dip by increasing the money supply or by reducing taxes. The pound is considered to be a "pro-reflation" currency, according to analysts.

For the markets, the prospect of further restrictions is very low considering that the government is against such measures.

Bank of England rates

Markets are expecting further interest rate hikes from the Bank of England, as they have already priced in 100bp of rate hikes in the next 12 months.

With the Bank demonstrating that is willing to raise rates despite Omicron concerns and additional political support for the November rate hike from Chancellor Rishi Sunak, markets are optimistic.

Currency markets are pricing in two rate rises by the Bank’s March meeting and a full percentage point by the end of the year.

The Bank raised interest rates for the first time in three years in December, despite the Omicron variant and at a time where thousands of people were forced to self-isolate. Financial markets expect a second interest rate rise from the Bank in February from 0.25pc to 0.5pc.

Despite market optimism, economists have warned that household savings are falling as higher prices are eating into budgets. At the same time, lenders are said to have the ability to lend and mortgage rates are expected to be competitive in the near future.

In the meantime, Andrew Sentance, who was a member of the Monetary Policy Committee between 2006 and 2011, intends to push for an investigation into the Bank of England’s role in raising rates and he will write to the chairman of the Treasury Select Committee and former Cabinet Minister Mel Stride this month. He criticised the BoE for being “dormant” and reluctant to take action.

 

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Sterling has started the new week lower as Omicron fears have gripped markets. The threat of new lockdowns has rattled markets across the world with all risk sensitive currencies, such as the pound, falling. With reduced central bank support and the ongoing pandemic, investors want to avoid unnecessary risks ahead of the Christmas period.

Global stock markets were also lower partly due to news that President Joe Biden's Build Back Better package did not pass the Senate. Safe-haven currencies such as the yen, US dollar and the Swiss Franc rose as risk-off sentiment turned investors to less risky assets. As it is commonly noted, the pound was lower against the euro which seems to benefit when global markets are down.

Sterling was however higher against commodity currencies such as the Australian and New Zealand dollars.

Risk aversion in global markets

Lockdown risks are rising in the UK as Health Secretary Sajid Javid has not ruled out stricter measures before Christmas after health advisers suggested that more restrictions were necessary to control the rising number of coronavirus infections. Countries such as The Netherlands will enter a full lockdown until at least the 14th of January, while various European countries are considering more restrictions to fight the spread of the virus. Reports suggest that tighter restrictions are expected to be introduced in Germany too.

The recent decline of the pound was driven by a risk aversion mood in global markets due to Omicron. The pound fell as is one of the risk sensitive currencies that falls when global markets seek to avoid risk and traders put their wagers on safe-haven currencies. For financial markets, especially foreign exchange markets, Omicron’s impact on the economy is considerable, and it could reverberate into the new year. Traders are concerned about Omicron’s effects on global growth at a time when central banks are focused on withdrawing support, including the Federal Reserve which will proceed to withdraw stimulus over the coming months.

Inflationary pressures

The introduction of new restrictions comes at a time where inflationary pressures persist, with the global economy struggling to return to pre-pandemic levels following 2020’s restrictions.

According to analysts, financial support programmes to mitigate against pandemic measures will become more costly, and central banks would want to avoid them.

Global growth risks have increased, as President Joe Biden's Build Back Better stimulus package has failed to pass, after Senator Joe Manchin said he cannot vote for the $1.75 trillion package as it will increase the country’s debt and push inflation higher. Americans are already struggling with high inflation taxes and utility bills.

The removal of accommodative monetary policy by many major central banks will affect risk assets and emerging markets, as many developing market currencies have weakened the last six months.

The pound will strengthen if risk sentiment improves, but, at the moment, due to the ongoing pandemic, uncertainty will continue.

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The pound has weakened due to the new Covid restrictions, and it could fall further, analysts have said. It failed to retain its momentum as the latest coronavirus headlines have put more pressure on the British currency.

Health Secretary Sajid Javid said that the Omicron variant is spreading at a "phenomenal rate" in England, but no Omicron-related deaths have been confirmed yet.

Covid threat is raised to Level 4

On Sunday, British Prime Minister Boris Johnson warned that the UK faces the Omicron "tidal wave" and he vouched that all eligible adults in England will receive the booster dose by the 31st of December. Downing Street explained that without the protection of a third dose, NHS beds would "quickly fill up and the long term damage to the economy and the NHS efforts to bring down the backlog will be even greater." The UK has now raised the Covid threat to “Level 4”, which is one level below the maximum.

Nicola Sturgeon also said on Sunday that the Scottish government will ensure that all adults have access to a booster dose by the end of the year, while Mark Drakeford said the Welsh government will try to accelerate its vaccination program.

3,137 Omicron cases have been reported in the UK on Sunday, which marks a rise of over a thousand since the previous day.

The pound could find it difficult to regain its footing as investors are evaluating the potential effect of the Omicron variant on the Bank of England's (BoE) policy decisions, which will be announced later this Thursday.

Plan B and Bank of England

The announcement of the government’s “Plan B” restriction measures to fight the spread of the Omicron virus was quickly followed by news that a so-called “Plan C” may soon follow, which will have a huge impact on the UK economy and currency as it adds to the uncertainty and potential delays of an interest rate hike by the Bank of England. 

According to analysts, BoE policymakers have already noted that the UK economy has likely met the requirements for an interest rate rise, but the Omicron variant adds significant uncertainty to the economic outlook and will likely mean that a rate hike will be delayed until February.

It’s possible that this week the BoE will leave the Bank Rate at 0.10% and that will push the pound lower. However, since markets are already expecting the bank to keep interest rates unchanged, the effect on the British currency will be limited.

The decision on whether to raise interest rates next week will very much depend on the current uncertainties about the health and economic impact of the Omicron wave, so the Bank is expected to keep a more cautious attitude and wait for more information before deciding to increase the cost of borrowing.

The pound is also expected to remain vulnerable ahead of the latest European Central Bank (ECB) meeting, which could allow the euro to strengthen further. The ECB is expected to announce an increase of its monthly bond purchases as part of its quantitative easing programme called Asset Purchase Facility (APP). However, the ECB could delay this decision due to the current uncertainties.

While expectations have been lowered, and February is most likely the time that the Bank of England might decide to lift interest rates, any surprise decision to lift the rate this week would provide a considerable boost to the currency.

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The pound has fallen against the euro as the market continued to avoid risk currencies in favour of safe-havens. On the other hand, the pound has gained support against the US dollar and reversed some of its losses from Friday following positive Brexit-related news. The UK has granted new licences for French ships to be able to work in British waters which was seen as a sign of progress and offered a moderate rise to the British pound. Apart from this, the broader market risk sentiment will influence demand for the dollar and set the tone for the pound.

Bank of England

A potential risk to the pound is the possibility of the Bank of England (BoE) postponing an interest rate hike on the 16th of December. BoE Monetary Policy Committee member Michael Saunders noted that the new Covid-19 variant has clouded the economic outlook and created uncertainty. Saunders clarified that it is beneficial to wait for more information before tightening monetary policy.

Omicron

Sterling fell against the single currency due to uncertainty regarding the new variant. The spread of the virus in South Africa suggests that this variant has higher transmissibility and affects immunity more significantly than other variants such as the Delta one. South Africa has reported an increase of 11,125 new Covid cases a day, on Sunday, which are less compared to previous days.

The Omicron variant has been found in more than 16 US states, and more cases are expected to be detected, according to Dr Rochelle Walensky of the US Centres for Disease Control and Prevention. Many of the cases were among fully vaccinated individuals who had mild symptoms, although it was not clear whether these individuals have had the booster. The Delta variant accounts for 99.9% of new Covid cases in the United States, Walensky added.

The emergence of such a variant threatens to disrupt efforts to end the pandemic. The World Health Organisation said that the Omicron variant will possibly spread internationally and poses a very high risk of infection that could have a very negative impact on certain places.

The coronavirus pandemic is not over and the next one could be even worse, the creator of the Oxford/AstraZeneca vaccine noted. Professor Dame Sarah Gilbert warned that while “this pandemic is not done with us”, the next one could be even more lethal.

With considerable uncertainty and lack of more information on how fast Omicron can spread globally, markets will remain volatile.

Pound: week ahead

The week ahead could be significant depending on how the market reacts  to new details about the threat of the virus. October’s UK GDP data due out on Friday morning will also provide a clearer view of the UK’s economic recovery in the final quarter. Friday’s GDP data is expected to show 0.3% pace of growth for October, an expansion driven by the services sector, which is now threatened by the virus.

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The pound has been lifted from its lows after the Bank of England disappointed markets by keeping interest rates unchanged. On Tuesday, the pound was higher as investors are now focusing on a February rate rise.

While speaking at a virtual event organised by the Bank of England (BoE), Governor Andrew Bailey stressed that they will have to act and raise rates if they see a clear indication that higher inflation is feeding into wages. His comments did not impact on the market pricing of a rate hike in December. The CME Group's BoE Watch Tool shows a 67.5% chance of a 20-basis points rate hike before the end of the year.

In terms of Brexit, the ball is now in the UK’s court. After the EU clarified that they will act accordingly if Britain were to trigger Article 16, they are now waiting for the UK to make the next move.

Economic growth and Bank of England

The Bank of England’s dovish turn and less aggressive policy is in line with market data and suggests that their interest rate decision was made based on a more restrained and conservative economic growth outlook. The Bank lowered its 2021 growth forecast to 6.7% from August’s 8.5% forecast but raised the 2022 GDP forecast from 2.3% to 2.9%. 2023's forecast has been lowered to 1.1% from 1.3% that it was previously.

Inflation

Inflation is expected to go over the 2.0% target in the coming months and the Bank could act by raising interest rates if it deems appropriate. Bank of England Chief Economist Huw Pill said on Friday Nov. 05 that he believes the pace of wage inflation will surpass both those of the Eurozone and the US.

A more measured Bank means that there are less risks for early tightening, especially if inflation proves to be transitory. This will also support economic growth and households which are already struggling with higher costs.

Economists do believe that the Bank of England will still raise interest rates to fight inflation in the near future, as they expect hikes in December and February.

Other possible factors to consider for pound volatility

  • As a procyclical currency, the pound goes up when global stock markets are strong and falls when they fall. If the pound weakens it is usually against stronger safe havens such as the US dollar, the yen and the franc. For now, market sentiment is positive, and this has given fresh impetus to the pound.
  • Brexit tensions are growing, and this could potentially impact the pound. Ireland’s foreign minister Simon Coveney warned that the EU-UK Trade and Cooperation Agreement could be dismissed if the UK triggers Article 16 and rewrite the protocol on Northern Ireland. The protocol, which is part of the EU-UK withdrawal agreement, was agreed in order to avoid a north-south trade border on the island of Ireland. Protestant Unionist parties have rejected the agreement, and two buses were set on fire in the past week. If the UK fails to maintain a border in the Irish Sea, then this will threaten Ireland’s economic rights as an EU member and it will be unacceptable by the 26 EU member states. Without a border, animal and plant products will enter the EU single market, without full legal controls. Ireland’s goods won’t be trusted, and checks will possibly be required in order to enter the EU. Markets will await any updates on Friday, following the EU and UK's chief negotiators meeting this week.

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