By Oliver Mangan
The UK is set to leave the EU next March, but there is still considerable uncertainty about what shape Brexit will take.
The lack of progress in the negotiations is giving rise to mounting fears that there could be a no-deal, hard Brexit.
This has been reflected in renewed downward pressure on sterling, with the euro climbing back up to around the 90p level.
There are numerous hurdles to be overcome to avoid a no-deal, hard Brexit.
An exit deal needs to be concluded between the EU and UK before the end of the year. This will consist of two elements.
The first element is the withdrawal agreement, which will largely cover the technical aspects of the UK’s departure, including citizens’ rights, future budgetary contributions, Irish border issues, and the transition period.
The second element is a ‘political declaration’ that will set out a broad framework for future economic, trade, and security relations between the EU and the UK.
It should be noted that while the withdrawal agreement will be legally binding, the political declaration is not.
Thus, this element of any exit deal can be left vague and be more aspirational and, thus, largely fudge the issue of customs and trade.
This offers the best approach of getting an exit deal concluded in the coming months. It also offers the best prospect of an exit deal being approved by the British parliament.
The deep divisions in the Conservative Party over Brexit mean that it could be a difficult exercise for the minority Conservative government to get an EU exit agreement through parliament.
It would help, though, if the political declaration element of the exit deal is vague on the issue of future trade relations.
Eurosceptic Conservative MPs could then support it and look to secure a harder Brexit in the trade negotiations that are due to commence after Britain leaves the EU.
Otherwise, they risk bringing down the Government on the issue.
This means, though, that it will probably still not be clear what the final shape of Brexit is, even when the UK leaves the EU in March.
The status quo would be largely maintained during the transition period that is to last from the exit date until the end of 2020.
The difficult decisions, in terms of future customs and trade arrangements, could be left to the detailed negotiations on reaching a new EU-UK trade deal to be conducted during the transition period.
Sterling is likely to remain out of favour until markets get clear signs that an exit deal can be reached. Thus, it could trade at around 90p versus the euro over the next couple of months.
We expect that, despite all the hurdles, an exit deal will be agreed and approved by the UK parliament.
However, given that uncertainty in regard to the precise nature of Brexit could extend into the transition period, the upside for sterling may be limited. EUR/GBP may only return to an 87-89p trading range if a deal is done.
Of course, if the chances of a no-deal Brexit continue to rise, then sterling is likely to weaken further.
The euro could move up to around the 93p level hit last summer, and may even reach the 95p level last seen during the financial crisis back in 2009.
Indeed, sterling could even fall to parity in the event that the UK crashes out of the EU without any deal in a very chaotic Brexit next March.
Oliver Mangan is chief economist at AIB