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Three Possible Brexit Trade Deal Scenarios

FX:GBPUSD   British Pound / U.S. Dollar
Yet another extension.
The initial deadline of last Sunday for the post-Brexit trade negotiation has just been extended. In a released joint statement after their call on Sunday morning, UK Prime Minister Boris Johnson and European Commission President Ursula von der Leyen felt that it is responsible for trade talks to continue beyond the deadline but did not state how long the talks will continue for.

What have been resolved so far?
Although the three sticking points of fisheries, level-playing field and governance remain, that is not to say that no progress has been made. Last week, the UK and the EU have come to an agreement in principle on the issue of Northern Ireland border checks. Both the UK and the EU have agreed that no checks will be required for goods moving between Northern Ireland and the Republic of Ireland as the former will remain in the EU customs unions and single market. Instead, border checks will be required between Northern Ireland and Great Britain.
Apart from this issue, the UK government has also agreed to remove the controversial clauses from the Internal Market Bill. Those clauses would allow the UK government to ignore parts of the Northern Ireland protocol requirements which is a breach of the Withdrawal Agreement and international law.

Three trade deal outcomes and how they may impact GBP/USD .
Looking at the chart, we see that the announcement of the departure of UK from the EU back in June 2016 has plunged the GBP/USD down to as low as 1.20. Since then, GBP/USD has been trading below the 1.34 handle for most of the time. Several attempts were made to break beyond that handle but were to no avail. At the moment, GBP/USD is hovering around the 1.34 handle.

Scenario One – A free trade deal is struck
The ideal scenario. In the event whereby both the UK and the EU arrive at a free trade agreement, GBP/USD has a potential upside of up to the 1. 40 handle. This still fall short of the level GBP/USD was trading at before the Brexit announcement was made back in June 2016 as the UK economy is still under pressure caused by the COVID-19 pandemic. Thus, for GBP/USD to break above the 1. 40 handle will require both a containment of the pandemic and a strong recovery of the UK economy.
Nonetheless, it will be very challenging for this ideal scenario to happen given that the Brexit transition period ends in two weeks’ time. Furthermore, the finalized trade deal will also have to go through the UK and European Parliaments before it can be carried out, thus leaving less time for a deal to be established.

Scenario Two – A partial free trade deal is struck with an extension of negotiation into 2021
This scenario is probably the most realistic one out there. It is no longer a surprise to anyone following the Brexit saga that a deadline will end up getting missed. No doubt 31 December is a hard deadline. But, given that the leaders of both countries are still pressing on for a free trade deal and that not establishing one is a lose-lose situation for both countries, they may come to a mutual agreement to strike a partial deal for now and carry on the negotiation into 2021 or, they may end up with a subpar deal (that is better than trading under the WTO terms) and put it up to the respective Parliaments for approval next year. Either way, the outcome will be positive but the upsize is limited to the 1.36 handle since there is still a level of uncertainty in the completion of the deal.

Scenario Three – No free trade deal is struck
The ultimate disappointment. Failing to establish a free trade deal would mean both the UK and the EU will be trading on WTO terms. What this would mean essentially is that tariffs will apply as stated in the WTO terms while border checks are mandatory, potentially creating traffic bottlenecks. This scenario will most likely send GBP/USD crashing to the 1.27 handle or lower if the COVID-19 situation in the UK continues to worsen since the costly tariffs will definitely add more burden to the current economic trauma.

With time running out, Brexit headlines are bound to be the limelight in the media. Also, volatility in any pound-related currency pairs is expected to be high. Soon, we will know in which direction will GBP/USD be heading towards.

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