The pound after Brexit

February, 2021

The following article discusses the impact of the UK's final exit from the European Community on the British pound (GBP). At the end of last year, after a long and unstoppable struggle between two partners, Great Britain and the European Union, an agreement on Brexit was finally reached. The trade agreement stipulates that most of the products involved in the commodity trade, including food, clothing, machinery and domestic appliances, will be duty-free, which is beneficial to the producers of both blocks. However, there are some terms in the contract that the UK partner may have some problems and those problems could affect the strength of their currency.

To be exempt from the import tax, the goods must meet certain conditions. One of these concerns the origin of the product itself. Many products contain many elements of which they are composed. Let's take a car for example, which represent this category very well. For a car assembled in the UK, to enter the duty-free category, at least 60% of its value must be manufactured in the UK or in one or more countries belonging to the European Union. This could create a big problem for the UK industry, which is supplied with semi-finished products mainly from China and some other Asian countries, as well as most Western countries. Many companies have realized that this will be one of the key problems that will arise in order to continue exporting to Europe at competitive prices.

In addition to this condition on the origin of the product, there is another potentially dangerous rule, the so-called equal conditions clause. What does it foresee? The product remains in the duty-free range until there are not significant differences in terms of rules and regulations. Neither side has to lower their standards if they want free trade to continue. If the British standards begin to deviate from European ones, a number of products to which these standards apply may be removed from the free trade list. Britain's long presence in the European Community has led to the fact that a large number of their standards have been harmonized with European's, so it is expected that there will be no such divergence on the part of the islanders. There is a certain fear of the British, that in the event of a turbulent relationship with the European partner, the latter may undertake a change in its standards to put the British state in difficulty.

All the business models they have created and studied at various British universities and scientific institutions, show that trade in goods between these two partners will be significantly reduced, given the obstacles that the new treaty inevitably imposes. As a result, some import prices will rise, and some export orders will simply be lost due to the loss of competitiveness. Normally this problem will have a significantly greater impact on the island's economy and their finances, as Britain's dependence on Europe is much higher.

A reduction in trade with Europe, the UK's largest single market, will mean a reduction in demand for its currency and therefore a lower value of the pound. It could also mean that UK companies will face less competition with EU exporters, which could lead to lower productivity. The reduction in productivity in the UK could also cause the sterling to fall in value, as in that case devaluation, the depreciation of money, is the only alternative to maintaining international competitiveness.

In addition to trade in goods, a very significant element that makes up a large part of Britain's gross domestic product is services. The UK, or London as the home of finance, has a very large financial market in Europe, which is again the largest single market. The agreement to leave the European Community does not include trade in services. The two sides are still negotiating an agreement that should include this element. The two strongest European countries, Germany and France, want to conquer the British-dominated part of the services market at all costs, so it is difficult to expect these negotiations to lead to a favorable outcome for the islanders and this will also help reduce trade.

In this first period, immediately after the formal entry into force of Brexit, from the beginning of 2021, due to the aforementioned problems, it is impossible for the United Kingdom to maintain the same level of activity compared to the previous period. Many believe that activity will remain subdued in the coming years as well, especially if they fail to reach a satisfactory agreement on trade in services. As services are the largest part of the UK economy, failure to reach such an understanding could significantly reduce the demand for sterling in European markets more than anything else.

Summarizing the situation, the Brexit deal will most likely contribute to the downward trend of the pound against the euro and the dollar. This fact will cause prices to rise in British stores and their visit abroad will be more expensive. Many believe that the euro will break even in nominal terms with the British pound in the coming years.

Analyzes of the best British businessmen and financiers are summarized above. The analyzes are well argued and certainly have their own strong logic, but... The experience teaches us that very often, even the best analysts in the world, make mistakes in predicting the future. The reality is so complex that it is almost impossible to take into account all the factors and variables, and even if it succeeds, the variations of the various parameters are so large that there are countless possible scenarios. Therefore, always be careful.