The Independent has reported that the two sides remain far apart and time is running out to bridge the gap.

The article explained that the ''UK and EU negotiators have met in Brussels over the past week to try and resolve major differences that have erupted over trade rules for Northern Ireland The talks move to London on Tuesday, and Britain says, substantial gaps on the fundamental issues remain.''

The article went on to say that ''the EU accuses Britain of trying to renegotiate a legally binding agreement that it signed less than a year ago; some officials say it shows the U.K. government can't be trusted.''

However, it was also explained that the bloc has, however, agreed to make changes to the deal, offering to reduce checks on food, plants and animals entering Northern Ireland by as much as 80% and to cut paperwork for transport companies in half.

Sterling investors will be pleased to know that Britain has welcomed those proposals, however, there remains the critical element left to be negotiated. The UK also is demanding that the EU's top court be stripped of its role resolving any disputes over the agreement and replaced with independent arbitration — an idea the bloc flatly rejects, as the article explained.

Trade war, a risk for GBP

The article reported that the ''chief negotiators Maros Sefcovic of the EU and David Frost for Britain are due to meet in London at the end of next week to assess the talks' progress. Britain on Saturday repeated a threat to trigger an emergency break clause that lets either side suspend the agreement in extreme circumstances if there is no breakthrough soon. That would bring legal action from the EU, and potentially economic sanctions that could spiral into a trade war.''

It has been regarded as more of a risk to the pound than the euro, although both sides stand to lose a great deal in such a scenario. ''Concerns about the UK’s growth outlook were highlighted last week by the IMF, which warned that the Covid crisis risks bringing more longer-lasting damage to the UK economy than any other country in the G7,'' analysts at Rabobank highlighted. 

''Any such battle is likely to hurt the economy of the U.K. more than the much bigger EU,'' The Independent's article stated also. 

''Irish Foreign Minister Simon Coveney also warned that talks couldn't go on forever, and urged Britain on Friday to respond to the EU's willingness to compromise.''

"I think the EU has shown a real appetite for compromise, and they have consciously avoided creating tension," he said. "I can't say the same in terms of the British government's approach."I don't think it will be the case forever, that the EU will be in compromise and solutions mode."

Market implications

While this is room to play out prior to traders reacting to sentiment, the markets are more aligned to what is happening between the central banks.

The Bank of England could proceed with an interest rate hike at the upcoming meetings or hold fire, given concerns around economic growth. However, the markets are pricing a chunky 34 cumulative bps in rate hikes rise from the BoE by year-end.