British Prime Minister Johnson is considering launching Article 16 of the Northern Ireland protocol. As the risk of brexit becomes the focus of attention again, all parties will return to the negotiating table, and the pound and the Bank of England may face digital risk events. Triggering Article 16 of the Northern Ireland agreement may cause the Bank of England to raise interest rates at a lower rate than current market pricing. If the risk of brexit reappears, the euro / pound may move to a higher level. (target will be 0.88)

At present, the Northern Ireland agreement is deadlocked again, and the British cabinet now expects Johnson to launch Article 16 in a few weeks. According to the terms of the trade agreement after Britain dragged Europe, Northern Ireland was retained as a part of the EU single commodity market to avoid the need for inspection at the Irish land border when goods entered the EU. This means that products exported from the UK to Northern Ireland are subject to inspection and control. According to the British government, this means undermining the stability of trade and supply chain. The European Commission has proposed many measures to simplify these Provisions, but the UK insists on completely rewriting the agreement to eliminate most inspections and controls.

Article 16 of the "nuclear option" Northern Ireland agreement allows either the UK or the EU to suspend any part of the agreement that causes economic, social and environmental damage or trade diversion. The British government stated that this condition was clearly met and was entitled to invoke Article 16.

Statistics Ireland's data in August 2021 showed that since the UK left the EU, the Republic of Ireland's exports to Northern Ireland have increased by 43%, while reverse flow goods have increased by 77%. In contrast, 50% of Northern Ireland enterprises said that the agreement had a negative impact on their business with the rest of the UK. This trade diversion constitutes the background against which the UK is (possibly) prepared to invoke Article 16.

If Johnson starts "nuclear option"

If Johnson invokes Article 16, both parties should enter into negotiations to seek a solution, and no measures can be taken during the initial month of negotiations. If the negotiations fail, Britain can adopt "unilateral measures" that are reviewed every three months.

In practice, this may mean that the UK stops inspecting goods that cross the Irish sea or are more stringent and suspends other parts of the agreement, such as product standards, customs inspections or VAT rules. Depending on the situation, the EU can take different "rebalancing measures". This is likely to trigger proceedings. However, if the UK is above the customs and single market regulations, the EU will respond more forcefully.

 

 

If Article 16 is triggered, brexit without agreement will be put on the table again

Irish Foreign Minister covini said that the EU may respond by terminating the brexit trade agreement, but we have obviously heard many similar empty threats from the EU before. In the case of termination, a 12-month "transition period" will be seen for the two parts to negotiate.

This looks familiar because it reproduces the dynamics of withdrawal from the treaty and subsequent trade agreement negotiations, which we previously described as a "prisoner's dilemma". If the EU suspends the agreement, UK exporters will lose duty-free access to the single commodity market. It is expected that the UK will fight back by increasing the cost of EU goods. This will make British goods more expensive and less competitive in the European single market, which is a bigger problem for Britain than the EU.

Britain cannot win such a trade war. In addition to exporters, British consumers will also face rising costs. For example, an analysis by the Institute of Finance in 2017 showed that about 30% of the food consumed by households was imported, of which 70% came from EU Member States. Overall, consumers will be affected by potential "no deal" disruptions, such as supply bottlenecks and rising energy costs, which will increase the cost of living. On the other hand, whether the termination of the trade agreement will eventually affect the reputation of Britain. It could undermine Britain's credibility as a trading partner as it seeks to reach trade agreements on a global scale.

The failure of Article 16 will hit Ireland and Britain hard

Triggering Article 16 may be bad news for all markets, including agriculture, which has performed poorly in uncertain periods, and the outcome of the negotiations will determine what will happen.

If the EU withdraws from the trade agreement, it will mean imposing full tariffs on agricultural products exported by Ireland to the UK, as well as on cross-border trade on the island of Ireland. Alternatively, the EU can initiate rebalancing measures, such as imposing targeted tariffs on sensitive products such as cars, whisky or fish.

This is similar to the situation we saw. At that time, the European Union imposed a 56% tariff on Harley Davidson bicycles imported from the United States, while other countries imposed taxes on important products supported by trump. Both are detrimental to Britain's fragile economy.

Nevertheless, when it comes to brexit, politics will trump economics. As Johnson's support rating declines, he may find it politically too attractive to fight the EU before the 2023 election, and when new unpopular blockade measures may be implemented this winter, a new fight with the EU may be politically rewarding.

 

 

What does article 16 mean for sterling and the Bank of England

We judge that if the uncertainty of the UK dragging Europe reappears, the euro / pound will return to 0.88, which may also undermine the Bank of England's interest rate hike plan. Just a year ago (before the EU and the UK signed a trade agreement), due to the uncertainty of brexit, the Bank of England decided to increase its quantitative easing program. The Bank of England said that the economic outlook remained extremely uncertain, depending on the evolution of the pandemic and the measures taken to protect public health, as well as the nature and transition of the new trade arrangements between the EU and the UK. It also depends on the response of households, businesses and financial markets to these developments.

We continue to predict that the Bank of England will have room to raise interest rates twice in 2022. If Article 16 is triggered before that, we expect them to avoid raising interest rates in December, which is based on the current basic situation.