Tensions between the EU and Britain over the Protocol on Ireland/Northern Ireland could create potential headwinds to the British currency. The pound fell last week following the Bank of England's decision to keep interest rates unchanged, and markets are now putting their hopes on a February hike. However, any upside potential will be hindered if the EU and the UK do not resolve their disagreement. Already, the EU has issued warnings if the UK triggers Article 16 of the Irish Protocol, while fears of a trade war between the two are growing stronger.
On Wednesday morning, Tánaiste Leo Varadkar warned British prime minister Boris Johnson that triggering Article 16 would be a “very aggressive and bombastic move” and noted that the UK will not end up with a better deal by doing so. Varadkar said: “The message I’d send to Boris Johnson is that we have an agreement in relation to Northern Ireland, we have an agreement in relation to trade with the European Union - don’t jeopardise it.” He added: “You were part of negotiating it, you own it, it was hard won, it’s a mistake to think that by escalating tensions or by trying to withdraw from any part of it, that you’ll end up with a better deal: you won’t.” Triggering Article 16 would allow the UK to suspend all, or part, of the treaty and will undo the Brexit deal resulting in the collapse of relationships.
Foreign exchange markets could build a premium into Sterling exchange rates as uncertainties over the future trading relationship between the UK and EU continue, posing considerable risks to the currency.
What is Article 16?
Article 16 is a clause in the Protocol on Ireland/Northern Ireland, which is an important part of the Withdrawal Agreement. The Protocol was created in order to avoid a hard border between British-ruled Northern Ireland and EU member Ireland by introducing some checks on the movement of goods to Northern Ireland from mainland Britain. Article 16 allows the UK or the EU to take action if they believe the Protocol will lead to "serious economic, societal or environmental difficulties."
The EU has cautioned Britain that triggering Article 16 would hurt relationships with the EU and destabilise Northern Ireland. By reopening the Protocol will create further complications regarding peace in Northern Ireland and protecting the EU's single market.
Brexit troubles will hurt the pound
The tensions between the EU and the UK and the prospect of a trade war over Northern Ireland will create potential risks to the pound. Financial analysts and strategists are cautious and believe the pound will trade with a more defensive tone as markets expect the UK government to trigger Article 16 of the Northern Ireland Protocol during the second half of November.
Markets will also be watching Friday’s meeting between the chief negotiators David Frost and Maroš Šefčovič.
Brussels Correspondent for BBC News, Jessica Parker, has reported that according to an EU diplomat the talks are rumoured to have been "extremely bad".
A worst-case scenario for the Pound would be the complete termination of the post-Brexit trade agreement, but this will be unexpected and a very extreme scenario. More likely, the EU could trigger legal proceedings and potentially impose tariffs on certain goods.
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