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Brexit: when to start buying pounds
Arguing over money will reduce the time available to discuss market access. This could be the trigger for another drop in the pound and we would be looking to buy if it heads towards GBP USD 1.15 given that valuation for the currency is looking very cheap.
Richard Jerram 30 Mar 2017

March 29 marks the start of the process of the UK leaving the European Union (EU) after 44 years of membership. We fear that the process will be more difficult than the market expects and this could produce one final leg down in the pound. With large budget and trade deficits, the UK is not well-placed to bear the costs of a messy exit.

Timing looks almost impossibly challenging. The UK will leave the Union in two years and to reach an agreement on such a complicated issue as market access – a new trade deal – in such a short time frame is hard to imagine.

Even so, there is going to be much less than two years. The European Union has suggested that it wants to come to a deal on the UK’s bill for exiting first, followed by discussions of residency rights of EU citizens living in the UK, and vice versa. Only then is it prepared to discuss market access.

The timetable is also squeezed by the need for each of the remaining members to ratify any deal, which is expected to take six months.

Realistically, this means agreement on market access post-Brexit will need to be completed in a little over a year. The UK simply lacks the expertise and resources for this to be realistic. As a result, some kind of transition arrangement seems likely to be necessary, but it is unclear if this will happen.

Negotiations over money are at the basis of many unpleasant divorces. The EU has suggested that the UK will need to pay around 60 billion euros to cover existing obligations. This is around 2.5% of the UK’s annual GDP and is meeting strong resistance from pro-Brexit politicians.

Arguing over money will reduce the time available to discuss market access. This could be the trigger for another drop in the pound and we would be looking to buy if it heads towards GBP USD 1.15 given that valuation for the currency is looking very cheap.

There is a reasonable risk that the UK leaves the EU in two years with no deal in place to obtain market access. Some politicians are suggesting that this is fine, but this looks like a bluff as part of the UK’s negotiating strategy.

There is almost no chance that other trade deals will be in place by 2019, as most of the limited resources will be devoted to EU negotiations. As a result, goods and services trade could be badly disrupted when the UK exits the EU. It might be the case that in the longer term the UK will benefit from a lower level of regulation outside the EU, but over the next few years the adjustment required by Brexit is likely to be painful.

The potential for another Scottish referendum and the complexities of Northern Ireland’s situation simply add to the burden. There are too many issues to resolve in such a short time frame.

So far it has remained steady, but the UK property market looks vulnerable to exiting with no deal in place. London will still have the attraction of being a great global city with a solid rule of law, but the financial sector has been an important source of wealth and that is likely to be eroded.

The UK’s economic performance has been better than seemed likely after the referendum last June. As in other developed economies, inflation has moved higher, and is likely to continue to rise as a result of exchange rate weakness. This has led to discussion of the possibility of the Bank of England (BoE) tightening policy within the next year, perhaps shadowing the European Central Bank. Given the uncertainties, we think the BoE is more likely to be patient and tolerate some overshoot of inflation.

There is also the question of whether Brexit will inspire others to leave. Frexit looks very unlikely, but before long we will have to turn attention to elections in Italy, which could be much more problematic.

Richard Jerram is chief economist at Bank of Singapore

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