Brexit and the Implications for Forex Trading Between The UK and the EU

UK Parliament

In the immediate aftermath of the Brexit referendum vote in 2016, the British pound experienced a precipitous slump that sent many British financial institutions and investors into a frenzy. Leading financial companies faced the immediate challenge of containing and adjusting to volatile currencies over the past year.

While the vote was a simple no or yes choice for UK citizens, the reality of leaving the European Union is the exact opposite.

There are many different potential outcomes for the UK One of the biggest issues facing businesses in the coming year is how to manage Foreign Exchange Market (Forex) trading between the UK and the EU now that the former has submitted its exit proposal. Risk management experts and investors are planning for a volatile few years as the UK finds its place in the international markets by establishing new trade agreements with the EU and other international partners.

In recent months, the pound has experienced a small bounce following a year of decline. However, risk management experts caution investors against reading too much into this rebound. As talks with the EU progress, many experts expect the pound to experience another decline as Britain moves more into a post-Brexit Forex position.

Expert Insight

Forex risk management expert James Stretton of JCRA describes 3 main options of dealing with potential depreciation of the pound. Businesses can: conduct international trade through hedges (fixed rates) instead of at the time of the vote; absorb as much of the additional costs and price increases that they can or; pass on cost increases to customers through product and service price hikes.

As expected, many larger commercial companies have already chosen to pass on the increase of rising import costs to their customers instead of absorbing the costs through company cost-cutting measures. Microsoft raised its cloud prices by 22% within months of the UK Brexit vote to make up a decline in profit due to the pound’s slump. Other tech companies, such as Apple, Dell, and HP, have also raised prices.

Smaller UK businesses that don’t have the same funding security larger businesses enjoy or name value to remain competitive, have chosen to revamp their supply chains and lock-in short and long-term hedges while the pound strength is high. For example, a business that makes 12 payments a year related to cross-border transactions (i.e. salaries, invoice payments, etc.) locks in an annual UK Forex trading rate through a third party e-commerce and exchange management service can maintain a relatively stable profit margin. This practice allows businesses to manage risks within a volatile exchange market currently being driven by geopolitics. Payment providers World First and Barclays have already reported a significant uptick in client hedging in the past month.

While either response provides a quick fix for near-term future UK-centric Forex trading issues, there is no guarantee that the pound will continue to hold at its current strength level or that consumer spending will remain at levels necessary to maintain market stability. In fact, UK economists fear the exact opposite due to a drop in recent consumer confidence and the looming threat of tech and financial industries relocating to EU member states.

How Markets are Responding

Since UK’s formal exit from the EU in March, there has been a significant drop in consumer confidence regarding the post-Brexit Forex UK market.

YouGov’s monthly measurement of consumer mood has found that rising inflation is spurring consumer fears about job security and living costs, “knocking consumer confidence to its lowest level since the aftermath of last year’s” Brexit referendum.

Market fears have already lead to the rise in food, clothing, fuels, metals, and other commercial industry prices, which have driven the UK’s inflation rate to its highest level in the last 3 years. Food prices have risen at the fastest pace on an average 1.2% per year. With household costs increasing, UK consumers have less disposable funds to spend on other commercial products, such as retail and travel and hospitality.

The UK

Wage growth in the UK has also slowed resulting in the first fall in living standards in 3 years. The Office for National Statistics showed that regular pay only increased by 1.9% compared to last year versus the 2.3% in overall prices. Business failure to adjust wages in order to keep up with inflation rates increases the possibility of a living standards crisis. This would cause negative ripple effects throughout the commercial and Forex trading in UK markets.

The Bank of England (BoE) recently concluded during its latest Monetary Policy Committee (MPC) meeting that consumer spending would be “slower in the near-term than previously anticipated” but forecasted it would recover within two years. Such a high optimistic prediction fails to take into account the reality of the geopolitical situation and would require a number of factors to go well for the UK.

First and foremost, the British government needs to ensure that the adjustment to new trade relationships with the EU is smooth. Unfortunately, the tone has been anything but.

EU Considerations

German Chancellor Angela Merkel recently rejected one of Britain’s Prime Minister’s key Brexit demands, insisting that Britain’s exit negotiations with the EU cannot run parallel to any new talks about future UK-EU trade relations.

The Prime Minister had included the demands in her formal letter triggering Article 50 that formally launched the separation process from the EU. Backed by the remaining 27 member states, the German Chancellor stuck to her script that issues, such as the rights of EU citizens in the UK, the final exit bill, and an approach to Northern Irish border, be agreed upon first before any trade talks take place that would allow UK continued access to its Single Market. Without new trade agreements in place, the UK is preparing to be in a state of “damage control” for at least the next two years as it navigates Forex trading without the EU’s support system.

In response, the UK’s Brexit minister, David Davis, said, “How on Earth do you resolve the issue of the border with Northern Ireland and the Republic of Ireland unless you know what our general borders policy is, what the customs agreement is, what our trade agreement is?”

In 2016 the UK shipped 54.3% of its exports to EU partners, while 21.1% went to Asia, 16.7% to the United States, and just 2.8% went to Africa.

With Germany taking a hard stance against any premature trade talks in a post-Brexit Forex environment, the UK may need to look elsewhere if they are to retain their competitive market edge against a combative EU.

Alternative Partnerships

A Regent’s University of London assessment in 2015 summarized this very issue. It proposed that there are readily available alternatives to EU membership, including: “joining the European Economic Area (EEA); joining the North American Free Trade Agreement (NAFTA) with Canada, Mexico and the USA; or creating a new free trade area with other Commonwealth countries such as Australia, Canada, New Zealand, India and South Africa.” While the benefits to joining any of these organisations, or to even rely on World Trade Organization (WTO) membership, are unknown, they still offer alternatives to the EU in terms of UK Forex trading. The negatives include geographical preferences, possible increased trading costs, and multi-year long negotiations.

If the UK is unable to secure an agreement with the EU, then it would need to operate under the WTO terms when trading with the EU or any of its member states. The WTO is an international agency with 164 member states, of which the UK and many EU nations are already members. One of the most important principles of the WTO is a ban on discriminating against other member states. This means that the UK and EU would have to impose the same fines and tariffs on each other’s imports. Currently, the UK doesn’t have any tariffs whereas the EU average is 4.8%. If forced to impose the same fines and tariffs as the EU, then the UK’s competitive edge would be wiped out.

A new trade agreement between the two partners would still be subject to the WTO’s terms, however, it would allow for greater integration and cooperation in the Forex trading market outside the UK.

The UK and South Africa just reached an “in-principle agreement that an interim arrangement will be put in place once Britain leaves the EU which will be based on the existing economic partnership agreement between South Africa and the EU.” This agreement ensures that the UK will have a smooth transition from an EU-based trade agreement with South Africa to a UK-based one that captures the improved market access for “32 agricultural products, especially wine, sugar and ethanol” the EU partnership was able to secure.

Another possible route would be to increase UK’s trade with China. China is already the 6th largest export market for British goods. From investment funds to nuclear technology and commercial goods, China has been a constant trade partner for the UK.

At the May 2017 Beijing Summit, British Chancellor Philip Hammond called China a “natural partner” and urged for increased trade with the global giant.

China’s recently promoted $900 billion infrastructure plan labeled the Belt and Road Initiative (BRI) would be an excellent opportunity for the UK to establish further trade connections with a country outside of the EU post-Brexit Forex atmosphere. The BRI is a global undertaking that would create an interconnected web of roads, pipelines, telecommunications, railways, and ports throughout Asia, North Africa, the Middle East, and Europe.

Despite its 1.3 billion total population size China has struggled in recent years to find enough labor and locations to support its steel, coal, and building sectors – sectors that are crucial to the success of its BRI proposal.

Currently, China is in a seeker phase. It needs to identify overseas labor markets and geographical locations that can support the BRI. If the UK is able to secure a seat at the table, such a program would provide the UK with multiple opportunities for profit and a chance to redefine itself as a global trading partner outside of the EU.

Whatever route the UK takes, the real world consequences of the Brexit referendum are already starting to put a strain on Forex trading in the UK as well as the living standards within the country itself. Until a collaborative relationship with the EU is established and the UK is able to secure additional trade partnerships with other primary global trade actors, such as China and the US, the market will continue to operate in a volatile state.

Global Commerce Redefined

Although Brexit’s ripple effects have been felt throughout the financial world, it’s abundantly clear that global trade won’t grind to halt because of current protectionist values that are being promoted in Europe and a number of other nations. Businesses of all sizes interact with clients and vendors across borders, and our ways of economic advancement are constantly evolving with emerging markets worldwide. If you manage a globally-minded company and would like to do business anywhere, Allied Wallet has the capabilities to expand your current reach through a comprehensive suite of merchant services, global payment gateways, and consumer solutions. With support for over 164 currencies, our merchant services know no borders. To learn more, please contact us our 24-hour support team in the UK at +44 203 318 8334 or reach us in the US at +1-888-255-1137.

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