Trade war: A more combative UK-EU relationship!

The UK is threatening to scrap Northern Ireland’s post-Brexit rules — stoking fears of a trade war

The U.K. government is again threatening to unilaterally override large parts of the Brexit deal agreed with the European Union, raising the prospect of a trade war amid a power-sharing crisis in Northern Ireland.

U.K. Prime Minister Boris Johnson on Monday will travel to Belfast in a bid to deescalate tensions over the Northern Ireland protocol, part of the post-Brexit trading agreement which requires checks on some goods entering Northern Ireland from the rest of the U.K.

The hastily arranged trip comes shortly after Northern Ireland’s largest unionist party blocked the election of a Stormont Assembly speaker — effectively preventing the formation of a new executive in the province.

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The Democratic Unionist Party, which came second behind Sinn Fein in May 5 elections, has refused to re-enter the executive until the protocol is rewritten. The deal came into force in January last year having been designed to avoid the need for a hard border between Northern Ireland and the Republic of Ireland, which remains part of the EU.

The DUP says U.K. lawmakers must abolish the protocol, arguing that a customs border has been created across the Irish Sea and this undermines Northern Ireland’s place within the U.K.

Sinn Fein, which accepts the protocol, has the right to nominate the executive’s first minister after becoming the first nationalist party to win the most seats in the 101-year history of Northern Ireland.

However, under a power-sharing agreement introduced in the 1990s, a new government cannot be formed without the DUP. The first minister and deputy minister must be one unionist and one nationalist.

The absence of a functioning devolved government has raised concern among U.K. lawmakers. That’s because, without it, there are fears of a return to street violence that could threaten the fragile peace since the Good Friday Agreement.

Signed on April 10, 1998, the Good Friday Agreement is a historic truce that brought an end to three decades of sectarian violence in Northern Ireland between Irish separatists and British loyalists.

Why is the protocol at risk?

Johnson — despite renegotiating and signing up to the Northern Ireland protocol — is again considering whether to make changes to the deal, a move that would risk retaliation from the EU and potentially kickstart a trade war.

Writing in the Belfast Telegraph on Sunday, Johnson said “there will be a necessity to act” over the protocol if the EU’s position does not change. He said the agreement was now out of date given that it was designed before the coronavirus pandemic, Russia’s war with Ukraine, and a cost of living crisis.

Foreign Secretary Liz Truss warned last week that the U.K. would have “no choice but to act” if EU lawmakers do not show the “requisite flexibility” over the protocol.

European Commission Vice-President Maros Sefcovic has said that it is “simply not acceptable” for the U.K. to make such threats, adding it continues to be of “serious concern” that Johnson’s government intends to embark on a path of unilateral action.

The EU proposed changes to the protocol in October last year, focused on further flexibilities regarding the area of food, plant and animal health, and medicines, among other issues. The U.K. rejected this plan.

“The U.K. government, for its part, is simply looking for what I think in the jargon of present political chatter at Westminster is known as ‘red meat,’” Christopher Granville, managing director at consultancy TS Lombard, told CNBC via telephone.

“So, latching onto an emotive Brexit-related wedge issue of the EU trying to divide up the U.K. and dictate to the U.K.— and the U.K. government shows it is standing up to Brussels and ditching the protocol,” Granville said.

When asked whether Downing Street’s position on the protocol appeared to be designed to distract the British electorate from issues such as the cost-of-living crisis and damaging local election results, Granville said: “Exactly. That’s my reading — and that’s why it comes around from time to time.”

“The reality is that the EU, under the Commissioner Sefcovic, has all along been open to discussing pragmatic ways to adapt the workings of the protocol and has gone along with various waivers and moratoriums … but of course, that doesn’t do the trick politically either for the DUP or for the U.K. government.”

Germany’s Olaf Scholz has called on the U.K. to avoid taking unilateral action over the protocol, while Belgian Prime Minister Alexander De Croo has said that the U.K. not abiding by the deal would create a significant problem for the EU’s internal market.

“Our message is quite clear. Don’t touch this,” De Croo said at a news conference alongside Scholz on May 10. “This is something we agreed on and agreements need to be respected.”

The U.S., meanwhile, has encouraged dialogue between Britain and the EU to resolve the impasse.

Former U.K. Prime Minister Theresa May has warned that the U.K. scrapping parts of the protocol could harm Britain’s reputation for abiding by international law.

Trade war

The U.K. government is not thought to have decided whether to trigger Article 16 of the protocol, a safeguarding mechanism that allows either party to suspend parts of the deal if it is seen to be causing serious problems.

Mujtaba Rahman, managing director at consultancy Eurasia Group, has estimated that legislation enabling the government to unilaterally override the protocol would take at least six months to one year to agree, citing opposition to the measure in the House of Lords.

“In the short term, a more combative UK-EU relationship is likely alongside legal proceedings restarted by Brussels, with the risk of a trade war only next year,” Rahman said in a research note.

Sterling was last seen trading at $1.2216 on Monday morning, down around 0.4% for the session.

“There’s plenty of reasons for sterling to weaken at the moment. First and foremost, the superior hawkishness of the U.S. Fed and the strength of the U.S. economy which can withstand higher interest rates compared to the stark risk of stagflation in the U.K.,” Granville said.

“But, at the margin, if the tail risk of the U.K.-EU trade deal blowing up were perceived to be fattening — which is definitely a scenario — then you could expect some additional weakness in sterling,” he added.