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There appears no easy quick way out to resolve the latest gridlock in UK-EU trade negotiations. Meanwhile, after heavy selling last week, the pound has rebounded this week but the outlook remains grim for the sterling. A deal is only probable very late in the day now and hence any short-term GBP bounce will not last with potential big GBP declines still to come, according to MUFG Bank.

Key quotes

“The UK government argues that the Internal Market Bill will act only as a ‘safety net’ but is viewed in Brussels as directly reintroducing the primary risk that both sides negotiated to avoid – the risk of a ‘hard border’ on the island of Ireland. That was agreed through the Northern Ireland protocol that could have resulted in an effective border down the Irish Sea if a trade deal was not reached. Michael Gove has been leading the negotiations of actually implementing the wording of the deal and has argued that the EU has been unreasonable in its demands of what was agreed in the signed agreement.”

“Understandably the EU sees the Internal Market Bill as a direct breach of the Northern Ireland protocol which was designed to prevent a hard border on the island of Ireland at the cost of creating a customs border in the Irish Sea. The EU has given the UK government until the end of this month to amend the bill and threatened legal action. The EU could refer a breach of the Withdrawal Agreement to a tribunal and ultimately the European Court of Justice either of which could end in fines.”

“A WTO trading relationship with the EU is not at all priced and in that context, GBP/USD falling to around the 1.2000-level is a realistic prospect if market participants see further reason to credibly expect no deal to happen.”

“The macro backdrop in the UK only adds to GBP downside risks. We don’t expect any policy change from the BoE this week but the need to cut rates and/or expand QE is growing. We expect that in February 2021 but we shouldn’t rule it out by November. If we continue to head toward no EU-UK trade deal, BoE action will be inevitable. All of these factors will be key for GBP direction over the short-term and for now mainly point to further GBP downside ahead.”