Watch sterling. The currency wobbled after UK international trade secretary Liam Fox said a "no-deal" Brexit was now the most likely outcome, falling to its lowest level in 11 months. On Tuesday, after perking up initially, sterling eased again, and was trading at about 89.5p against the euro, getting into danger territory for Irish exporters.
If investors really start to believe there will be no deal, we will see sterling hitting the skids. So far most investors still believe that, somehow or other, a deal will be done. But the UK currency stands exposed now if the talks don’t get back on the rails in the autumn.
A no-deal Brexit would be such a mess that common sense suggests a way will be found to avoid it. But common sense is not very much in evidence, and it looks like, when the political world resumes in September, that we may well be seeing a period of tension as everyone realises that time really is starting to run out.
After a period of stability this year, with sterling trading generally within a range of 87p to 89p against the euro, we could be looking at some fireworks ahead. And politics will drive it.
The Bank of England increased interest rates last week, a factor which would usually support sterling. Instead Brexit fears have led to it losing ground.
Irish exporters have benefited from the reasonable stability of sterling this year, according to Simon Barry, chief economist with Ulster Bank in Dublin, but he sees risks of volatility ahead and the danger of weaker sterling if a "no-deal" scenario looks likely.
“The balance of risks is certainly on the downside,” he said, pointing out that, since the referendum in the UK we have already seen sterling rise well above 90p on a couple of occasions.
Irish exporters
International commentary in recent days from a number of major banking groups has warned of a 10 per cent “downside”risk for sterling if the talks go off the rails, although there could be a significant upside for the currency if a softer Brexit is seen to be on the table.
This kind of downside, bringing sterling closer to parity with the euro, would be very problematic for Irish exporters. Sterling bottomed out at 70p against the euro towards the end of 2015, a boon for exporters. And while it had generally been around the mid-80p for a prolonged period before that, we can’t forget that sterling has already lost 13 per cent against the euro since the referendum. We are on the brink of danger territory, and a sustained move above 90p would set alarm bells ringing.
A Bord Bia survey in 2017 suggests that 40 per cent of Irish food exporters start to experience difficulty above 89p, rising to 80 per cent above 94p.
Separate Ibec research points to slowing export growth above 85p, with real difficulties starting to hit at rates above 90p – at which point every 1p extra takes a toll.
Particularly exposed are smaller companies that export solely to the UK or that do not have the resources or expertise to hedge their currency exposure.
The UK currency has a wide impact, of course, going well beyond exports. Weak sterling also threatens inward tourism from the UK, and encourages cross-Border shopping by residents from the Republic, with the import of cars from the UK already a significant issue depressing new car sales south of the Border this year.
Downward pressure
Weakness in the UK currency also puts downward pressure on the price of UK goods in the Irish market, meaning increased competition for Irish producers on the home market. The UK is by far the biggest market for imported consumer goods, and sterling weakness has been a factor in keeping the price of goods in the shops from rising. The upside of weak sterling is that it boosts the spending power of Irish shoppers, though in net terms this does not cancel out the risk to our exports.
Currency forecasting is a risky sport– and the outlook for the euro is also uncertain.
In relation to sterling, if you wanted to put it down to one issue you could say that warning lights will start to flash red for sterling if the transition period, due to kick in when the UK leaves in March 2019, is threatened.
During the transition period there would be a kind of standstill until the end of December 2020, giving time to try to work out the bones of a trade deal. But if there is no withdrawal agreement between the UK and EU covering the terms of Britain’s departure, then there will be no transition.
We have spent a lot of time recently discussing the possible impact on Ireland of various kinds of Brexit, focusing on areas like possible tariffs and other barriers to trade. Sterling's recent stability has moved it out of the focus. But if the weeks ahead feature an increase in the recent "hard Brexit" speculation, sterling will be back in the headlines.
Own margins
Sources say that, as sterling has hit the 88p-89p level, firms have generally taken the cost into their own margins and tried not to pass it on to customers. They are sitting tight and hoping for a soft Brexit and some sterling recovery. In the same way many big banks and manufacturers have been waiting for some clarity before deciding what action to take.
However we have seen some moving, with – for example – some Irish manufacturers establishing UK bases to be sure of retaining easy access to that market, and banks now based in London establishing operations in Dublin, Frankfurt or wherever so they have guaranteed access the EU market post Brexit.
The trouble is that, due to the chaos in London – and the complexity of the whole enterprise – the political negotiations have failed to give any clarity. And it is hard to know when any might emerge.
Perhaps something might be cobbled together to allow the transition period to come into force and provide some breathing space. Or perhaps it will all just fall apart. Either way, the next few months won’t be pretty. For a clear take on what investors think is likely, watch sterling.
