The deadline for Brexit is less than five months away. Both the European Union (EU) and the United Kingdom do not want to walk away without a deal, since that would likely entail economic damage not only to the U.K. but also to the EU, as the U.K. is their biggest trading partner.
Yet an agreement between the two still seems far away. Interestingly, the foreign exchange market hasn't responded much to the continued uncertainty of the deal.
To complicate matters further, the topic of how to treat Northern Ireland is now the dominant factor — something that very few voters ever thought would become so critical.
The island of Ireland is split between the Republic of Ireland — commonly known as “Ireland," which is predominantly Catholic and part of the EU — and Northern Ireland — which is predominantly Protestant and part of the U.K. During the Brexit votes, Northern Ireland actually voted to remain in the EU.
As we all know, there is a notorious and bloody history between the two that was largely resolved 20 years ago when the Belfast Agreement was signed. So much work was done to achieve peace that all sides today want to preserve the open border between Ireland and Northern Ireland with no checkpoints or surveillance cameras. However, this creates direct economic conflict in light of Brexit, and neither the EU nor the U.K. can agree on how to achieve this.
The EU suggests that Northern Ireland can stay aligned with EU trade rules with no customs since they voted to stay within the EU. But the U.K. rejects this, saying that it undermines the integrity of the U.K., creating a gulf between England and Northern Ireland. The U.K. proposes a “common rulebook" for food and manufactured goods, with customs declarations and VAT checks done electronically for other goods. More detail needs to be ironed out on the tariff and customs front, so the U.K. has also proposed a temporary “backstop" transitional period until 2020.
The EU has rejected this, saying that a time-limited scheme will not work.
Our View: Brexit is not easy to resolve, and there is little time left to undo a marriage that started back in 1973, when the U.K. first joined the European common market. The market is probably immune to the lack of breakthroughs on Brexit because it's hard to discern what kind of agreement is the right one. It could also be because the U.K. economy hasn't really suffered much economic loss since the vote in 2016. Related to this, recent economic data suggests that the Bank of England is not necessarily derailed from its steady tightening path into next year either. Only time will tell whether this is the correct reaction.
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