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Sterling drops as escalating Brexit tensions threaten possible trade deal

EU’s Brexit negotiator Michel Barnier

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Sterling has weakened against the U.S. dollar on Monday morning as escalating tensions between the U.K. and the EU are threatening any chances of a post-Brexit trade deal in the coming months.

Sterling dropped about 0.5% against the USD in early European trading hours ahead of another round of trade talks between the U.K. and EU Monday and increasingly acrimonious relations.

There are two main issues threatening to derail the entire process: differences over state aid and fisheries. The prospects for a deal were dealt another blow overnight after news that the U.K. government is preparing to override previous agreements with the EU.

If we can’t agree by (mid-October), then I do not see that there will be a free trade agreement between us.

Boris Johnson

U.K. Prime Minister

In a statement Sunday night, U.K. Prime Minister Boris Johnson said: “There needs to be an agreement with our European friends by the time of the European Council on 15 October if it’s going to be in force by the end of the year.”

“If we can’t agree by then, then I do not see that there will be a free trade agreement between us, and we should both accept that and move on,” the prime minister said.

The possibility that both sides will not reach a deal is a problem for many exporters and could ultimately shake financial markets.  

“It is very difficult at the moment to see how the gridlock, the deadlock can actually be broken,” Rebecca Harding, CEO of Coriolis Technologies, a trade analysis firm, told CNBC’s Squawk Box Europe.

She explained that without a deal with the European Union, “it is going to be very difficult for the U.K. to keep those supply chains running.”

The U.K. stopped being a full member of the European Union in January, after voting in 2016 to leave the political bloc and after about three years of intense negotiations over the departure.

Back then, the U.K. and the EU agreed to give themselves some more time to develop new trade arrangements and avoid a sudden shock at their borders. The deadline to do that ends in December.

The EU had previously said that October was the key moment to achieve new trade arrangements, so there would be time for the necessary legislative processes before implementation on January 1, 2021.

However, over the last months, U.K. and European negotiators have complained about the lack of progress in their negotiations.

“We are worried about the state of play of the negotiations with UK,” Michel Barnier, the EU’s chief negotiator, said after the last round of talks.

The biggest stumbling blocks are state aid and fishing rules.

“From the very beginning we have been clear about what we can accept in these areas, which are fundamental to our status as an independent country,” David Frost, the U.K.’s negotiator, said Friday ahead of a new round this week. “We will negotiate constructively but the EU’s stance may, realistically, limit the progress we can make next week,” he added.

There are only two final rounds of trade talks scheduled before October 15.

In addition to the lack of progress in trade talks, the U.K. government is reportedly preparing new laws that will change previous agreements with the EU.

A government bill, due to be published Wednesday, is expected to override a previous deal that aimed to prevent a hard border between Northern Ireland and the Republic of Ireland, the Financial Times reported Sunday.

The EU’s chief negotiator, Michel Barnier, has often said that the implementation of this border agreement is crucial to ensure a successful trade deal.

“This would be a very unwise way to proceed,” Simon Coveney, the Irish minister for foreign affairs and an important player in EU-U.K. negotiations, said on Twitter.

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