Pound heading for a crash if Britain fails to get a Brexit trade deal

The British pound could plunge by 10% or more if the United Kingdom does not finalize a trade deal with the European Union this weekend.

Currency traders who once assumed a deal would be completed before a Brexit transition period ends on January 1 will be nervously watching events over the next 72 hours after British Prime Minister Boris Johnson warned late Thursday that the “deal on the table” was not “right” for the United Kingdom.

Johnson traveled to Brussels on Wednesday for dinner with European Commission President Ursula von der Leyen. But the last-ditch effort failed to produce a breakthrough on thorny issues including fishing rights, government aid for companies and how disputes would be settled. Officials have returned to the negotiating table ahead of a mutually agreed deadline on Sunday.

“The binary outcome [deal or no-deal] is on a knife’s edge which potentially sets the pound up for an outsized move once the Brexit saga reaches its finale,” Han Tan, a market analyst at FXTM, said in a research note. The fact that the pound hasn’t yet “capitulated” against the dollar suggests there’s still “pent-up hope” that a deal will be secured, he added.

The pound had been trading close to $1.35 earlier this month when a deal between the United Kingdom and its biggest export market looked more likely. Analysts have warned that the currency could quickly plunge below $1.20 if it becomes clear that a deal is no longer possible. The pound shed 0.6% on Friday to trade just above $1.32 as hopes for a deal took a knock.

Jordan Rochester, a strategist at Nomura, said the currency could weaken further after an initial plunge to $1.20 as UK trade adjusts to life outside the vast EU market of 450 million people.

A fall below $1.20 would push the pound to its weakest level since a shock flash crash in late 2016. It would also complete a dramatic fall for a currency that was trading above $1.45 in the months before the June 2016 Brexit referendum.

A weaker pound could help British exporters cope with the Brexit shock but it would push up the prices British consumers pay for food and other imports.

Time is now running very short. Johnson said he has directed his negotiators to go “the extra mile” in pursuit of a deal ahead of Sunday, but talks have foundered for months on the same set of issues and both sides appear dug in despite the huge economic costs — especially to the United Kingdom — of not reaching a deal.

Johnson said on Thursday that he had directed his cabinet to prepare for talks to fail, and the European Union has released plans aimed at keeping its borders open to commercial aircraft, trains and trucks. Johnson and von der Leyen said earlier this week that a decision would be made by the end of this weekend, but analysts have suggested that yet another extension is possible if substantial progress is being made. The immovable deadline is December 31, the expiry date for arrangements that have provided Britain with all the trade and economic benefits of EU membership after its exit in January 2020.

The cost of Brexit

Leaving the European Union means higher costs for UK companies under any circumstances, but departing without a new arrangement on trade could be catastrophic. It would leave Britain to trade with its single largest export market on World Trade Organization terms, subjecting the movement of goods and services to tariffs and other barriers.

The UK Office for Budget Responsibility (OBR), which produces economic forecasts for the government, said in November that even if London and Brussels are able to reach a deal, their new trading relationship is expected to lead to a long-run loss of output of around 4% compared to Britain remaining in the European Union.

But a no-deal Brexit would reduce output by an additional 2% in 2021, or some £40 billion ($53 billion), and consign more than 300,000 people to the unemployment line by the second half of next year, according to the OBR.

The United Kingdom is already facing a growing jobs crisis and suffering its worst recession in more than 300 years as a result of the pandemic. Bank of England Governor Andrew Bailey said last month that economic destruction caused by a no-deal Brexit would be worse in the long run than the pandemic.

“It takes a much longer period of time for what I call the real side of the economy to adjust to the change in openness and to the change in profile in trade,” he said in testimony before a parliamentary committee.

— Hanna Ziady and Julia Horowitz contributed reporting.