Brexit forecast: More chaos and eroding value

Of all the things that we seek to forecast in the world of economics and finance,

exchange rates are notoriously difficult to predict, because so many imponderables actually influence the value of a currency.

The value of a currency vis-à-vis any other currency is determined by many different variables. These include relative economic performance, relative interest rates, political developments and the big imponderable — sentiment.

All of these factors are currently moving against sterling and this week the currency went over 91p against the euro and has now reached its weakest level against the currency since early in 2010.

The weakness of sterling is being driven by many factors, but in a nutshell the UK economy is losing momentum and the eurozone economy is gaining momentum, inflation is coming under considerable upward pressure due to the impact of currency weakness on

import prices, and most of all, sentiment towards the currency is poor due to the inter-related issues of Brexit uncertainty and political chaos.

This week the UK government issued a position paper on Britain’s post-Brexit trading relationship. Basically, once the UK leaves the EU in March 2019, it wants to have an interim arrangement whereby it would remain part of the EU Customs Union for a defined period, but at the same time would be free to negotiate its own trade deals with third countries.

The EU Customs Union is the element of the EU that allows goods to be traded freely between the member countries. Goods imported into the EU from outside only have one customs

process to come through; a common external tariff applies to third-country trade; and any trade deals negotiated with third countries must be done by the whole customs union block rather than by individual countries.

Hence last year, for example, we saw the EU conclude a trade deal with Canada, rather than any individual country within the EU.

The paper goes on to suggest that once the interim time period is over, seamless customs borders would be put in place between the EU and the UK.

It is hard to see what a seamless border might look like unless the second option outlined in the position paper is put in place, namely, a new customs union deal between the EU and the UK. The problem here is that the EU would struggle to ensure that once goods enter the UK from a third country, correct tariffs and duties apply before they enter the EU from the UK.

It looks like a logistical nightmare and pretty unworkable. It seems inconceivable that the EU-27 would allow the UK leave the EU, remain part of the Customs Union for a defined period, while at the same time be free to negotiate trade deals with other countries.

From an EU perspective, such an outcome would represent a total nonsense and it is impossible to see what the possible upsides for the EU would be from such an arrangement.

The potential downsides are quite significant as it would undermine the whole basis of the EU. It seems clear that the whole Brexit process is becoming ever more chaotic by the day, and the UK side has not got a clue as to how the whole situation might unfold.

Meanwhile, against this chaotic background, sentiment towards sterling is again deteriorating at a steady pace and notwithstanding earlier comments about the folly of trying to forecast exchange rates, it does appear likely that sterling could fall further over the coming weeks and months given how toxic sentiment towards the currency is at the moment.

This is not good news for many Irish businesses, particularly around the border region. This factor will have to be a key consideration in the framing of Budget 2018.