Prime minister Boris Johnson’s plan to overwrite parts of the Brexit Northern Ireland protocol risks adding to inflationary pressures and pressure on the pound, according to economists and market commentators.
With consumer price inflation expected to climb to a 40-year high of 9%, or even higher, this week, the government is threatening to bring in new legislation, overriding parts of the protocol to remove checks on goods crossing the Irish Sea.
Agreed by the UK and EU as part of the Brexit deal, the protocol requires customs declarations and checks on all goods moving from Great Britain to Northern Ireland, which essentially created a trade border in the Irish Sea.
As this has contributed to the collapse of Northern Ireland’s political power-sharing arrangement, Downing Street is said to be planning the new domestic legislation that would mean no customs checks are necessary on goods leaving Great Britain that stay in Northern Ireland and do not then go to Ireland and the EU.
"This situation may add to the downward pressure on economic activity and the upward pressure on inflation," said Paul Dales, chief UK economist at Capital Economics.
"If the EU were to eventually retaliate by placing tariffs on the UK’s exports, the UK government could respond by placing tariffs on imports from the EU."
Dales added that the average import tariff could increase to around 2.5% from 1.0% if imports from the EU were subject to the UK’s global tariffs rather than the UK/EU zero-tariff Brexit deal, which would add about 0.4 percentage points to CPI inflation.
"But we would be surprised if the UK government actually did this as it can choose what tariffs it sets on UK imports. In effect, the government would be choosing to exacerbate the cost of living crisis."
Instead, more Brexit drama is more likely to boost inflation by weakening the pound, Dales said, including by creating uncertainty, which would weigh on economic growth.
Sterling has over the past three months plunged from US$1.36 to US$1.22 and €1.207 to below €1.17 last week.
Speculators have increased their short currency positions in the pound (among other currencies) in recent days, noted Marshall Gittler at BDSwiss.
"Speculators’ position in GBP is getting rather extreme," Gittler said.
"They’ve only been this short 3% of the time over the last five years. There could be a snap-back if anything good happens for the pound.
"My guess though is that only bad things are going to happen in the near future, especially when it comes to the looming fiasco over the Northern Ireland protocol."