by Jason Martin
Editor's Note: Below, the first installment of a 2-part series examining the current state of Brexit negotiations and potential knock-on effects. Part 2, which discusses possible consequences for the EU can be found here.
As the months continue to drag on in the Brexit “negotiations” between the European Union (EU) and the UK, little progress has been made on the issues that really matter to markets. Indeed, the window may well be closing for Britain to pen a “good deal” in its future trade arrangements with its “soon-to-be” former European partners.
Among the major concerns for the UK will be the economic impact of new agreements to be hammered out with regard to business with its largest trading partner including customs and tariffs, or the possibility of job losses as firms opt to shift operations to other parts of Europe which remain in the EU, along with absolutely all aspects of bilateral ties between the two associates.
Negotiations regarding the UK’s departure officially began on June 19, nearly a year after the June 23, 2016 referendum results decided that Britain would leave the group of 28 EU members whose bloc was created in order to establish a political and economic powerhouse that, among other things, would allow the free movement of people, goods, services, and capital within the internal market.
Negotiators from both sides have been meeting face-to-face for about one week every month, but few signs of progress have apparently been made. The EU has insisted that talks must first focus on agreements over rights for citizens from each region that are currently living in the other's domain, the border between EU member Ireland and British-controlled Northern Ireland, and the amount of money the UK will need to fork over to the EU as part of the “divorce fee” that is meant to cover Britain’s financial obligations to the European bloc.
Both parties have discussed in detail what rights their citizens living in the other region should have when the separation becomes official, but those talks have done little more than outline what they agree or disagree on and what needs further discussion.
Both the UK and EU appear to agree that the Irish border is a special case that should be handled with care in order not to damage the progress made on the 25-year peace process.
The main sticking point before the EU will allow discussions on a future trade agreement to begin appears to be the “divorce bill”. The EU is claiming that the UK should pay around €60 billion (£53.5 billion, $70 billion), but UK Prime Minister Theresa May has suggested a much lower amount, around a third that size.
The EU has indicated that progress has been made, but it is so far insufficient for talks to advance to the next stage of future trade deals. After the sixth round of negotiations ended on November 10, the EU’s chief Brexit negotiator Michel Barnier demanded clarifications on this aspect of the deal within two weeks’ time in order to push on to the second phase of talks, including trade.
The European Council, which includes the heads of state of EU member countries, has scheduled a so-called EU summit for December 14-15. It is the event that is, currently, expected to provide the next defining moment for Brexit negotiations, when the EU could approve moving ahead with negotiations over future trade with the UK.
Failure to receive approval would be considered a major setback as both sides head into 2018, moving quickly towards the March 29, 2019 official break-up date. Both groups fervently wish to have breathing room, as any eventual deal will need to be approved by politicians from each region in what would likely be a time-consuming process.
On the EU side, the draft deal would be sent to the European Council where it needs to get the green light from 20 of the 27 members, representing 65% of the population, before being sent to be ratified by the EU Parliament.
In the UK, Prime Minister Theresa May promised she would seek the approval vote on a “take it or leave it” basis in both the House of Commons and the House of Lords of the UK Parliament.
At the clamor of British businesses, May has been pushing to seal a transition period with the EU that will maintain current arrangements as both partners work through the fine-tuning of any deal. “A strictly time-limited implementation period will be crucial to our future success,” she has said. Hopes again settle on that mid-December EU summit for at least securing permission to begin discussing trade and transition arrangements.
British Brexit Secretary David Davis indicated that the UK is hoping to achieve agreement on the implementation period in the first quarter, which would suggest that both parties would have only about a year before the official divorce date to iron out details. A transition period could be key as it would provide a cushion of time post-Brexit as the new deals begin to be implemented.
At stake currently, without clear "divorce proceedings," is the ability for companies to establish their break-up contingency plans, as they continue to be mired in the uncertainty of what final framework the UK and EU might agree on. The Confederation of British Industry (CBI) warned that, according to a survey of businesses, only about 10% had begun to implement plans for a “no-deal scenario”, known as a “hard Brexit”, though 60% of British firms said they would take steps by the end of March.
“This is an extraordinarily important time for the Brexit negotiations, that run-up to Christmas, where businesses really need more certainty and more clarity and the reason why it has become so urgent is that we’re now in the window of decision making,” the CBI director general Carolyn Fairbairn warned on November 5 in an interview with the BBC.
“The message from us, from business, is more certainty quickly, particularly around transition, particularly in the next four weeks,” she added.
CBI president Paul Drechsler noted at a conference on November 6 that the largest and best-resourced UK firms were leading the way with contingency plans, but warned that small and medium-sized businesses were “struggling to plan, to predict, to calculate”.
At the same CBI conference, BT Group chief executive Gavin Patterson also insisted that time was running out for firms to start making their decisions and urged clarity, warning that companies would have no choice but to plan for a hard Brexit.
“The beginning of next calendar year (a transitional deal) is going to begin to deteriorate in value,” he said.
“Ultimately the planning horizon, of most businesses I certainly talk to, is the order of a year to 18 months,” Patterson explained. “If you don’t have certainty at that point you have to start planning for a worst case scenario,” he concluded.
According to the European Central Bank’s top bank supervisor Daniel Nouy, around 50 banks operating in the EU from Britain have approached supervisors to request information on how to relocate and continue operations. However, Nouy also noted that the ECB was concerned about many other banks that were still delaying their contingency plans.
But British and European firms aren’t the only ones trying to deal with the plague of uncertainty.
Lloyd Blankfein, Chairman and CEO of Goldman Sachs (NYSE:GS), appeared to be making his preparations back in October when he praised his time in Frankfurt in a tweet that provided a clear reference to the idea that financial firms could well move operations to the German financial capital and claimed he’d be “spending a lot more time there”.
Nevertheless, a mere 11 days later, Blankfein seemed to backstep, underlining the uncertainty involved in the Brexit process as he promised that GS would move forward with plans to develop its European headquarters in London, though he admitted that Brexit negotiations left “so much outside our control”.
In the worst case scenario, known as a “hard Brexit”, where the two sides fail to come to an agreement on trade, World Trade Organization rules would be applied to products sent from the UK to the EU and vice versa. Many industrial products would suddenly see tariffs added of just 2% to 3%, but cars would see a 10% tax tacked on, while many agricultural products would have a tariff of between 20% and 40%.
British businesses exporting to the EU would also suddenly be required to present their goods to the UK’s customs authority HM Revenue and Customs (HMRC). A backup system has already been laid out, implying that the same duties would be applied to every country with which the UK has no special deal. The HMRC estimates that about 130,000 businesses that export to the EU would most likely be dealing with customs for the first time.
Needless to say, the no deal scenario would likely take its toll on the British economy. By the numbers, UK economic growth is projected to have dipped to only 1.7% this year, compared to the 1.8% expansion registered in 2016. However, on a comparative basis, the UK registered the second largest expansion of the G7 countries last year, while its third quarter growth this year came in at just 0.4%, leaving it on track to repeat the second quarter’s reading, the weakest rate of growth in the group. Furthermore, the country is set for its worst annual growth performance since the depths of the recession after growing just 1.0% in the first nine months of the year, its slowest rate of expansion for the January to September period since 2009.
Experts remain convinced that some agreement will be reached between the UK and the remaining 27 EU members over trade and a transition period. However, the International Monetary Fund (IMF) warned in its latest regional economic outlook that it had not run a scenario where no deal was reached, but was certain that a “disruptive” Brexit would likely have a damaging impact.
“If the United Kingdom leaves the European Union without an agreement, there will be a notable increase in trade barriers, potentially accompanied by disruption of services in various sectors, with significant negative impact on economic activity,” the IMF said, adding that it would result in “appreciably lower growth than we presently project”.
Perhaps the clearest impact from Brexit uncertainty can be seen in the pound. Cable is down around 12% from the closing price of $1.4879 on the day before the results were announced.
Although sterling has managed an impressive recovery from October lows, in part due to the Bank of England stepping up to control inflation with policy tightening, an agreement between the UK and EU over Brexit remains a major risk factor for the currency.
“The December EU summit will be a make-or-break moment for our positive sterling call,” ING strategist Viraj Patel recently explained. “If divorce negotiations remain deadlocked and progress towards a transition deal stalls, our fear is that the pound could turn into the ‘big short’ of 2018.”
BoE is concerned about hard Brexit possibility
In its latest inflation report, which coincided with a rate hike, the Bank of England (BoE) also admitted that Brexit was the “biggest determinant” of its outlook and set down the observable impact that the decision to leave the EU has already had.
The overshoot of inflation throughout the forecast predominantly reflects the effects on import prices of the referendum-related fall in sterling.
Uncertainties associated with Brexit are weighing on domestic activity, which has slowed even as global growth has risen significantly.
And Brexit-related constraints on investment and labor supply appear to be reinforcing the marked slowdown that has been evident in recent years in the rate at which the economy can grow without generating inflationary pressures.
Not unlike British businesses, the BoE also admits that it can do nothing other than wade the waters of uncertainty in the current situation.
“The impact of Brexit on the forecast will evolve as negotiations progress. In particular, any resolution of the uncertainty about the nature of, and transition to, the UK’s future relationship with the EU insofar as it affects the behavior of households, businesses and financial market participants would prompt a reassessment of the economic outlook,” it said.
“In the short term, without question, if we have materially less access (to the EU's single market) than we have now, this economy is going to need to reorient and during that period of time it will weigh on growth,” he said in a November 5 interview with ITV.
Barnier’s remarks that the UK has a two-week deadline to give clarifications on its financial responsibilities to the EU puts the countdown into further perspective. Failure to put the first phase of talks behind them in time for the December summit would only exacerbate the uncertainty that is currently plaguing British firms.
While the debate still rages over whether the UK will or will not be better off outside the EU, the window may well be closing to avoid a hard Brexit and nail down a good trade deal. Tick-tock!
To read part 2, click here.
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