This week, UK Prime Minister Theresa May invoked Article 50 of the Lisbon Treaty. This legally starts the departure of the UK from the European Union, known as “Brexit.” And it starts the clock ticking for a two-year negotiating period to agree on the legal terms of the breakup.
At stake is whether the UK can strike a deal to regain power over lawmaking and immigration without giving up too much in trade benefits with the EU, its largest market, or losing the dominant status of London as a major financial center.
The expectation is that the EU will not make the process too easy, out of concern that other member states follow the Brits in their exodus.
EU's calculated cost for Britain's divorce is around 60 billion euros (~$60 billion), a sum endorsed by member states such as Austria and even Sweden, one of Britain's closest allies. But the UK government has described that number as “absurd” – and some UK officials have even suggested that they don't have to pay anything.
Interestingly, in the currency markets since Brexit, the British pound (GBP) has not weakened as much as was anticipated. A small minority of analysts have even called for the pound to start rising, citing its oversold position, the resilient UK economy and the fact that triggering Article 50 actually reduces ambiguity.
My view, however, is that the current “unfazed” GBP is not a permanent reaction but partly a function of the weakening U.S. dollar.
There are still many uncertainties surrounding how quickly or slowly the negotiation process will take:
- UK wants to discuss trade, immigration laws and the cost to leaving the EU simultaneously. However, the EU wants the UK to agree to its 60 billion euro obligation before trade talks begin.
- PM May's strong mantra of “better to have no deal than a bad deal” does not bring the remaining EU nations into a free trade agreement as the UK wants, though she seems to have recently softened her stance.
- Article 50 is vague, adding to the complexity of the negotiation.
If negotiations are too slow, foreign banks may begin pulling out of London, as they now have to evaluate where the UK will be in terms of the Brexit process in two years. The worst case scenario would be that negotiations stall and there is no agreement after two years.
In that case, World Trade Organization rules kick in with higher trade tariffs for the UK, which would be detrimental to the UK economy. Hence, I believe the GBP still faces a lot of challenges that will potentially limit its upside.
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