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Prime Minister May changes her strategy. What now for Brexit and the pound?

29 Jan 2019 14:23|Marcin Lipka

"After the UK Parliament rejected the Brexit plan, the House of Commons takes more initiative in preparing the terms for leaving the EU. Prime Minister May, who, thanks to a reduction in the heated dispute inside the Conservative camp, is also taking a second breath and is hoping to accept an entirely new solution. What impact could these events have on the pound in the hours and weeks to come?" writes Marcin Lipka, Conotoxia Senior Analyst.

Only two months left for the adoption of the EU exit agreement prepared by British and EU negotiators. The last attempt ended with a tremendous defeat for Prime Minister Theresa May as the negotiated solution was rejected in mid-January by the vast majority in the House of Commons (432 votes to 202). What is next for Brexit? Is the UK in danger of a chaotic exit from the EU?

Struggle to avoid a catastrophe

The risk of a hard Brexit has recently decreased significantly. The rejection of May’s plan does not imply that the UK is heading towards the edge of the cliff. This can be seen, for example, in the opinions of the members of the House of Commons, most of whom are in opposition to leaving the EU without an agreement.

On the other hand, the British Parliament has clearly taken the initiative to discuss various forms of future relations with Brussels in recent days, but at the same time to rule out a hard Brexit. To this end, several amendments will be submitted at today's House of Commons meeting, which, for the most part, gives all the interested parties more time for reflection and delays the prospect of a chaotic Brexit.

The most significant amendments are prepared by members usually composed of both opposing parties (ruling Tories and opposition labourists). The amendment prepared by the moderately conservative, Nick Boles, and a representative of the left, Yvette Cooper, could gain the widest support.

The Cooper-Boles initiative assumes that unless the British Parliament approves an agreement presented by May’s Cabinet by February 26th, the moment of exiting the European Union is likely to be postponed to the end of 2019. This would give more time to develop a new agreement. It is worth noting that the EU will not necessarily accept this solution, if it does not contain acceptable backstop proposals (e.g. aiming to create at least a customs union). In addition, the initiative of moderate members of the House of Commons is likely to be supported mainly by labourists and liberal democrats. The core of the Conservatives may support another idea that appeared in the ruling circles only last night.

Tories have softened and want a longer transitional period

Given the incoming amendments to this House of Commons meeting and the expected support for them, at night the Conservatives decided to draw up a broad plan also to reduce the divisions within the ruling group (an extension of Sir Graham Brada's amendment on the backstop proposals). In a document that has leaked into the media (including the BBC), the solution proposed by the Conservatives assumes that if a new trade agreement and the backstop conditions are not agreed upon in the interim period, it will be extended by one year, i.e. until the end of 2021. During this period, as encouragement to accept this form by the EU, EU contributions will be paid.

Probably this solution does not satisfy the most Eurosceptic Tories, but it is likely to win more votes in favour than the last plan. However, despite the postponement of the actual exit from the EU, it still does not solve the backstop issue, although it extends the time to modify it or incorporate it into a future trade agreement that is yet to be negotiated.

It is also difficult to specify exactly how Brussels will respond to this. The temporary backstop has been ruled out by Ireland. However, if future trade relations with the EU remain close, perhaps an alternative scenario could be prepared. In general, Brussels may be more sceptical about the Conservatives' plan than a strictly parliamentary initiative. The backstop issue is less likely to be resolved in a positive way compared to the next steps resulting from the Cooper-Boles amendment. Also, the risk of a chaotic Brexit seems to be greater in the context of government action than in the case of the full takeover of control by the House of Commons.

Effects on the pound. Likely to exceed 5 PLN

Investors relatively quickly estimated that the risk of a chaotic exit from the EU was decreasing. Since the beginning of the year, the pound against the dollar has gained about 3 %, and in comparison to the zloty - 3.5%, growing by less than 0.20 PLN and reaching levels similar to one and a half year highs (4.95 PLN).

It appears that strong support of the House of Commons for the Cooper-Boles initiative would be beneficial for the pound. Such a solution would demonstrate Parliament's increasing parliamentary control over the Brexit process and a clear reduction in the risk of chaotic departure from the EU. Then, even today the threshold of 5 PLN per pound could be exceeded. Further increases would be probable, if the present or future parliament were willing to have close relations with the EU (a customs union, or perhaps a common market, or even no exit from the Community).

An initial response from May’s cabinet to the new plan (modification of Sir Graham Brady's amendment) would be unlikely to help the pound, mainly because the Union could reject it as a result of the ambiguous approach to the backstop. It is also uncertain whether the plan is likely to be adopted by the House of Commons, even though the highly divided Conservative camp is bringing it closer together. In general, the Tory initiative also shows a willingness to reach a compromise and avoid a chaotic Brexit, which should ultimately be positive for the pound.

29 Jan 2019 14:23|Marcin Lipka

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