Our Opinion: 2018
Agreement on path to Brexit
An agreement was reached this week on a transition deal for the UK and EU27 covering the initial 18 months after the UK exits the European Union in March 2019 – positive news for the UK economy, and particularly the Pound.
The announcement that the negotiators for the EU27 and the UK have agreed on the terms of a transition deal has been welcomed by politicians on both sides, as well as the currency markets. The terms of the transition deal contain few surprises.
Economically, little should change for the UK, as it will remain a full participant in the single market and customs union, abide by EU rules, and continue to make payments into the EU budget. Politically, much will change as the UK will no longer have representation at the main EU bodies that set the rules for the single market. The agreement on the transition deal lessens the downside risks to the UK economy in the short term, as it should reduce the need for companies in the UK to make immediate adjustments to their operations. If the economy continues to press ahead at its current rate (growth around 0.4% quarter-on-quarter), it is likely that the Bank of England will hike rates when it convenes for its policy-setting meeting in May, and Sterling is likely to build on its recent strength.
Despite the expected reaction from the Brexiteers in the Conservative Party, it is unlikely to scupper the deal, since they have their eyes on the bigger prize. Protesting about fishing rights is one thing, but leaving the EU remains the goal, and it is already notable how quiet the hardliners have been compared to how we think they could have reacted.
But one question remains unanswered that could eventually derail the talks: Northern Ireland. The so-called “fallback option” demanded by the EU27 still seems an unacceptable position for the Prime Minister, as it would essentially mean splitting up the UK single market. The current political arithmetic, which leaves the Conservatives reliant on the Democratic Unionist Party for their majority in parliament, muddies the waters further.
It is still difficult to see how the Northern Ireland question can be solved without knowing what the future trade and customs arrangements between the UK and the EU will be, and the full picture is unlikely to be known until the end of the transition phase at the earliest.
Nevertheless, a compromise solution is likely to be found, needing some imagination and compromise on both sides – something that the EU27 has been unwilling to show in the negotiations so far.
Agreement on the transition period opens up the next phase in the negotiations, which are discussions on the future trade relationship. There is still the possibility that the final agreement could be rejected by UK politicians, or the EU for that matter and, as underlined by both sides, “nothing is agreed until everything is agreed.”
As the year progresses, there seems a high probability that uncertainty will return around the time Parliament meets to ratify the exit agreement (most likely around October). It is also likely to remain high during the transition period as the UK and the EU27 try to flesh out the new long-term trade relationships. The 21-month window that is provided by the transition period looks extremely ambitious given how long it usually takes the EU to negotiate trade deals. This will keep alive the prospect of a ‘cliff edge’ moment for the UK come the end of 2020. This makes it unlikely that we will see a surge in business investment, boosting growth, anytime soon. Nevertheless, if current levels are maintained, the economy should remain on a steady path.
There is positive news from other sources. Global growth is set to remain decent, which should support UK exporters, and the UK labour market continues to show strength. In addition, the peak of inflation seems to have passed, which is another factor that should further support the Pound in the months ahead.
24th March 2018