The EU summit in October, which according to the original schedule was supposed to bring a major breakthrough in the Brexit negotiations, does not actually end until this afternoon, but as early as yesterday evening it became clear that the hopes of significant progress would be dashed. Theresa May’s 15-minute address offered no new insights and instead the Prime Minister called on the EU to offer creative and innovative ideas. What might a few months or even weeks ago have been considered a negotiating play is now truly serious. Time is running out fast and there is still no constructive solution to the Ireland problem in sight. The bone of contention remains the so-called “backstop solution”: Should the British not agree to a customs union with the EU and no other “technical” solution be found, then the EU would continue to treat Northern Ireland as part of the single market. The special status this would invariably spell for Northern Ireland is not acceptable to either the British government or the Northern Irish DUP. May’s latest suggestion, binding the British at least for the foreseeable future to a customs union with the EU, has however been equally savaged in Great Britain. In a renewed attempt to find a compromise, the proposal now is to extend the transition phase until the end of 2021. This would not solve the Irish border problem, but it would give the negotiating teams more time to reach agreement on the future trade relations. The probability of the “backstop” being activated would thus be far smaller. The Brexit hardliners are, however, hardly about to agree, as from their point of view every additional delay increases the risk of Great Britain remaining bound to the EU forever.
This morning the situation is thus more intractable than ever. We continue to believe that the political will to reach an agreement predominates on both sides. However, the risk of the negotiations coming to nothing has clearly risen in recent weeks. The EU cannot cede too much ground to the British without risking its own credibility. May’s hands are likewise tied given the deep split within her cabinet and parliament. Despite this seemingly hopeless situation, the Pound sterling has been astonishingly resilient. Clearly, many market players continue to think that the outcome will not be so bad. However, the fear of negotiations failing can be seen from the trend for risk reversals: There, bets on a devaluation of the Pound sterling have risen appreciably. Such a sceptical structure was last seen directly in the wake of the EU referendum.