Brexit: “Great moment of national change”

Insight
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18 January 2017

May’s plan contained little new information but offered a useful, comprehensive clarification of the government’s collective view Prime Minister Theresa May set out a twelve-point summary of her government’s objectives for the upcoming Brexit negotiations – her most comprehensive outline to date. Achieving such an outcome would, to our minds, likely minimise the long-term economic costs we expect from the UK’s decision to leave the EU. However, we see significant obstacles to the UK achieving these outcomes. Sterling appreciated 2% on the speech, which we consider as profit-taking, rather than a relief rally on the confirmation of a Parliamentary vote over the final Brexit deal.

Annex A provides a comprehensive review of PM May’s 12-point plan. May confirmed her preferred timeline for a March 2017 triggering of Article 50. She discussed several aspects of separation including migration, the ongoing strength of the United Kingdom, the Commons Travel Area in Northern Ireland and ongoing science and research projects.

However, from a macroeconomic perspective, we focus on May’s comments on future trade deals. May stated that the UK would not seek to be part of the Single Market, accepting that the priority of migration control and moving beyond EU law would not be consistent with the EU’s four freedoms. Instead, she proposed a “comprehensive Free Trade Agreement (FTA)” between the EU and the UK with a modified customs union deal, that would allow the UK to negotiate other trade deals beyond the EU. This has been our expectation* , but we believe that such an outcome is unlikely to prove an easy or quick process. May suggested that such a deal may take aspects of the current Single Market. However, we still consider the government’s expectation that this can be achieved within the two-year Article 50 timeframe as unlikely. Hence we look to a “transition deal” to spare the UK and EU from a “cliff-edge” separation in 2019 and May hinted at this as she discussed a “phased in process of implementation”.

Our concern remains that the timetable to negotiate what looks set to be a complicated separation/transition/comprehensive replacement FTA is short. Triggering Article 50 in March 2017 will make this timetable effectively shorter still with a risk that key EU nations (France, Germany and Italy) could be pre-occupied with domestic elections over the first few quarters of the negotiations. These concerns were part of reason for the resignation of the British Ambassador to the EU Sir Ivan Rogers at the start of the year. He viewed such a negotiation as likely to run into the 2020s. Such a time frame is more consistent with the seven year EU-Canada deal, not yet fully implemented.

Moreover, there remains an ongoing concern that the scale of Single Market access that the UK seeks, may not be seen appropriate by EU members fearful of further disintegration of the EU; and even if the UK were to make ongoing ‘voluntary’ Budget contributions in reciprocation for such access. PM May said she was confident that an agreement could be reached, which did not undermine the EU, was “economically rational” and would ensure future co-operation on trade and security. However, May suggested that if this were not the case, the UK would have the freedom to “set the competitive tax rates” and be free to “change the basis of Britain’s economic model”.

Our own view is that the UK faces a difficult and likely protracted phase of negotiation after it triggers Article 50. We see this as contributing to uncertainty, particularly if progress on a transition deal is slow, which could weigh on business investment (although we acknowledge mixed signals in the immediate aftermath of the referendum) and put more downward pressure on sterling. Sterling rose by ≈2% on May’s speech to $1.24 to the US dollar, which we believe reflects profit taking on short GBP rather than a rally on the confirmation of Parliament’s final say on the Brexit deal. To our minds, PM May confirmed many of the issues that sterling has weakened on in recent months and we are wary of suggesting today’s rebound will persist. The pass-through of softer sterling to headline inflation may also undermine the, to date, solid consumer spending experienced since the referendum.

Annex A - PM May’s twelve-point plan

  1. Provide certainty where can. May cited recent examples of farm and university payments clarifications as evidence of this approach. She added that the Great Repeal bill will in effect internalise EU law in the UK at the point of exit. However, in stressing the delicate nature of negotiations she reprised previous ministerial commentary that there will be “no running commentary”. May also committed to allowing both Houses a vote on the final deal. However, given the take it or leave it nature of such a vote, we are not convinced this will prove meaningful.
  2. Leaving the EU will mean laws made in the UK. A commitment to move away from EU legislation, but to allow for the appropriate delegation of responsibilities amongst the devolved governments.
  3. Strengthen the union of the UK. This will include involvement of the devolved governments in the negotiation process. Beyond that little detail of the substance.
  4. Prioritise “practical solution” to maintain commons travel area with the Republic of Ireland.
  5. Controlling the number of people coming to Britain from EU. May stated the UK always wants immigration, “particularly high skilled” immigrants, but she added when the numbers get too high it adds to pressure on schools, infrastructure and wages and “public support falters”. However, she gave no detail as to how migration might be controlled. She said the Home Office was looking at alternatives. However, in questions May twice referred to the “brightest and best”, which suggests most immigration could be based on high-skilled workers.
  6. Guarantee the rights of EU citizens living in Britain and Britons living in other member states “as early as we can”. May suggested this was something she had already suggested to other members, but said that “some” were holding back.
  7. Build on “rights of workers” as set out in European legislation.
  8. An “ambitious Free Trade Agreement with the EU”. May conceded that Single Market access was not possible without the EU’s four freedoms and being covered by EU law. Instead, May said she wanted a comprehensive FTA with the freest possible access for goods and services. She even suggested such a FTA might take aspects of the Single Market as a starting block. Importantly she said that the UK would not be obliged to make budget contributions to the EU once it left. However, she suggested the UK might choose to contribute to aspects. Discussing budget contributions in the description of an FTA suggests the government considers the possibility of ongoing ‘voluntary’ payments to the EU as a possible vehicle to achieve market access.
  9. Rediscover role of “great, global trading nation”. Develop trading relations with those outside the EU. May gave examples of China, Brazil, Gulf States, Australia, New Zealand and India as countries that have expressed interest in a UK trade deal. She also noted President-elect Trump’s “front of the line” comments. May highlighted this was inconsistent with current EU Customs Unions rules, but suggested different options that might get around this issue. For her though, the priority was overseas free trade deals.
  10. Welcome collaboration with EU partners on major science, research and technology initiatives.
  11. Work closely with EU allies in foreign and defence policy.
  12. Phased process of implementation. May said she wanted to have “reached agreement about our future partnership” within the two year Article 50 process. She then discussed a “phased process of implementation”, reflecting that it was in one’s interest for a “cliff-edge” or “ “threat to stability”. She said that such a “phase-in” process would be bespoke for different issues, with differing timelines, including possibly for the “legal and regulatory framework for financial services”. Such a “phase-in” plan or “transition deal” may be all the more necessary if the hoped for comprehensive FTA is not achieved within the allotted two-year time frame.

* Page, D., Extract from “Brexit”, - “…while we expect an FTA to be crafted between the UK and EU … we expect a tailor-made solution for the UK, it is likely to be different from the current Swiss model, AXA IM Research, 18 February 2016

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