Saker Nusseibeh, Chief Executive:
One of the main flaws of this entire process, indulged in by both sides, is to talk as if the effects of Brexit would be instantaneous or clear-cut once it is triggered. To restate the obvious, Brexit is a long, complicated and arduous set of negotiations, of which the commercial outcomes and their long-term effects on the economy are unlikely to be clear for many years to come.
The most immediate effect of the Brexit vote (a 20% devaluation of our currency) was not about the outcome of Brexit per se, but merely a logical hike in the risk premium for UK assets while we wait to see whether the effects of whatever can be negotiated are good or bad for the country in the long term. Triggering Article 50 can therefore be likened to embarking in a raft or canoe down a very windy and dangerous set of rapids. All we know at present is that the journey is long, the path of the rapids will likely take unusual twists and turns, and that the ride will be turbulent.
Whether we arrive at the end of the rapids in a wide tranquil lake, under glorious sunshine with strains of Elgar’s Nimrod playing in the background, or whether we sail over a waterfall with the sound of Colonel Bogey is anyone’s guess at present. However, I rather hope and pray it will be the former, and not the latter scenario that transpires.
Neil Williams, Group Chief Economist:
Buckling up for a long journey...
After nine months in the departure lounge, the exit door is now open, but it removes only some of the uncertainty for investors. After Theresa May’s explanation of the Brexit process and The Supreme Court ruling, the UK’s hoped-for departure date and destination look clearer, but the biggest question now is about the length of the journey ahead. I fear our negotiations could stretch well beyond the two years assumed by Article 50.
Mrs May says no other countries’ membership models will be sought, which seems to rule out Norway and Switzerland’s associate memberships. Yet, her desire to “pursue a bold and ambitious free trade agreement” with the EU suggests she will negotiate to maintain access to – but no longer full membership of – a tariff-free system (akin to Canada’s deal), and/or a customs union (similar to Turkey’s).
Access to a tariff-free system or customs union could be the best of both worlds...
Even this will need time. First, when the deal is struck it will need Parliamentary approval, and then be subject to a ‘phasing in’ period (Mr Hammond has suggested two years) to allow firms, consumers and officials to adjust to the new arrangements. A second independence referendum in pro-EU Scotland, though not precluding Brexit, could also provide an extra hurdle to completing it before the General Election scheduled for May 2020.
Second, the UK is relying on a cooperative sign-off by its 27 EU peers. The only real precedent we have is Greenland’s ‘exit’ in 1985. This was a ‘soft’ exit, but it took three years. We, larger and 44 years entwined in the EU, will need longer. Canada’s EU deal last year came after seven years of negotiation, and was toward the end stalled by the Belgian state of Wallonia.
We’re opening the ‘trapdoor’ in a highly-charged political year. Voters facing national elections in Germany, France and probably Italy may want to approach it as protest to six years of euro-zone austerity. In the ‘peripheral’ economies, reform fatigue and populist parties are building. Incumbents may thus be reluctant to condone an easy UK exit that puts its economy ahead of their own.
Third, EU law forbids trade-deal ‘bigamy’; in terms of enacting agreements elsewhere while still an EU member. This prevents a quick compensating tie-up with the US for example. Therefore, a challenge is to remain close to the European negotiating table to maintain the best trade and regulatory deals for services, which account for 80% of the UK’s gross value added. This makes it more ambitious than a Canada-style deal.
Governor Carney’s ‘blind eye’ would be akin to King’s when the CPI breached 5%...
Which leaves the BoE watchful that a weaker pound does not pump inflation. Should protectionist forces in the US and Europe build, which seems likely, inflation will reappear. But, it will be the ‘wrong sort’ – cost-push, led by tariffs, goods and labour shortages, rather than ‘feel-good’ demand-pull. Central banks will ‘turn a blind eye’ as economies stagflate.
Our simulations show at current USD/GBP and oil prices, RPI inflation this April lifting to +3.6%yoy, from February’s +3.2%yoy. But, combinations of a weaker pound and/or higher oil could feasibly take the RPI past +4%yoy. This would be a five-and-a-half year high. In each case, the CPI remains above its +2%yoy target this year. Further GBP weakness and/or oil strength would push it through +3%yoy.
Nevertheless, should that occur, I still doubt the MPC would react, given the feared hit to growth and the housing market. This would be akin to the ‘blind eye’ Governor King turned in 2011 when the CPI climbed to +5.2%yoy as the pound weakened and energy/food prices rose.
Consequently, we could be choosing one of the worst times to negotiate an exit, given the anti-establishment feeling in the US and Europe’s election calendar. And, we’ll now have to compromise if we want tariff-free trade, after all, this is our second European ‘divorce’, after the ERM in 1992. Therefore, any tie-ups in the future, with Europe or elsewhere, will probably come ‘with strings’. A bit like EU membership then!
Budget Commentary: Fiscal tweaks – a warm-up to triggering Article 50