UK: The final countdown begins to unfold

On 17th January 2017, Theresa May, the British Prime Minister (PM) who is expected to trigger article 50 of the Treaty on European Union1 (EU) by the end of March, outlined her blueprint for the UK’s exit from the EU.

Six months after she succeeded David Cameron in the aftermath of the June 23rd referendum, Mrs May made her fullest statement yet on her approach to Brexit, finally getting rid of the vague mantra of “Brexit means Brexit”. In a 12-point plan for Brexit, the Prime Minister made clear that she wanted a clean break from the EU, substantiating the idea that she would pursue what detractors labelled a “hard Brexit” and deciding to withdraw the UK from the single market.

Theresa May endorses hard Brexit

Mrs May, at last, lifted some uncertainties surrounding the future relationship between the UK and the EU. In a long anticipated speech, she confirmed that she interpreted the vote on June 23rd as a mandate for a clean break from the EU and ruled out the adoption of a model that would put the UK “half-in, half-out”.

Mrs May judged that, in the trade-off between free movement of people and membership to the single market2, control of immigration should be at the expense of the latter. The PM also emphasised that the government would not seek full membership of the customs union, which would in effect, prevent the UK from negotiating independent bilateral trade deals with the rest of the world. The emphasis on ending the jurisdiction of the European Court of Justice also pleased hard-line Brexiteers.

A transition period to limit the impact of a Brexit shock

Mrs May stressed that Britain would seek a “new, comprehensive, bold and ambitious Free Trade Agreement (FTA)”. This statement seems to confirm that the government will push for a “customised” bilateral agreement, which would focus on key sectors. Its main goal is to make trade with the EU as “frictionless as possible” and will aim for a partial customs agreement. She also acknowledged the need for a transition period in order to “give business enough time” to adjust. Hence, she pleaded for a “phased process of implementation”.

Westminster will get a final vote on the deal

Anticipating the High Court decision due later this month, Mrs May made clear that she would put the deal (expected to be obtained in late 2018) to a vote in both Houses of Parliament3. Pro-EU campaigners welcomed this decision, as they hope it will soften her stance in the negotiation. Nevertheless, she did not explain what would happen if the deal was turned down in Westminster.

Hardly veiled threats

With Brexit talks set to begin in late March, this speech was also an opportunity for Mrs. May to demonstrate the British government’s bargaining power in future negotiations. Responding to voices calling for a “punitive deal”, the PM warned that she was ready to walk away from the negotiation table: “no deal for Britain was better than a bad deal for Britain”, she asserted. Mrs May echoed the declarations from the Chancellor4 – Philip Hammond – when she asserted that Britain would aggressively cut taxes and red tape to poach investment and foreign companies.

A sense of clarity gives a short-lived boost to the pound

Investors responded positively to the general tone of Mrs May’s speech. The greater degree of clarity on the government’s objective, the pledge to give a vote to Parliament, as well as the acknowledgment of a need for a transition period provided investors with a sense of relief.

Mr Trump’s observation in the Wall Street Journal on Tuesday that the strong dollar was “killing” the American economy probably amplified the pound’s sharp rise. On equity markets, London’s FTSE 100, mainly export-oriented, headed in the other direction and fell 1.5%. European stock markets also closed in the red but, contrary to the FTSE 100, mitigated their losses after Mrs May’s speech.

Risks : Brexit likely to hit growth in 2017

The British economy has proved quite resilient since the referendum thanks to a buoyant services sector and private consumption. Nevertheless, with higher inflation (2.5% in 2017, on the back of a lower GBP), the private consumption is likely to erode in 2017. Business investment is also expected to slow until uncertainties on the outcome of the negotiations are lifted. The construction and automotive sectors could be impacted by higher prices of imported materials. Exporting sectors are not the most at risk in the short-term, as they could benefit from the lower level of the pound. Coface GDP growth forecast for 2017 for the UK remains subdued at 1.1% this year.

The United Kingdom in peril?

First Minister of Scotland, Nicola Sturgeon, speaking after Mrs May, stressed that a new vote on Scottish independence was now “all but inevitable”. With 68% of Scottish voters backing “remain” in last year’s referendum, Mrs May’s decision to move away from the single market brings closer a second referendum (after the one held in 2014). Hence, it may prove challenging for Mrs May to deliver on her pledge to preserve the “precious union” between England, Scotland, Northern Ireland and Wales. In spite of a pledge to avoid a “hard border” between the Republic of Ireland and Northern Ireland, Mrs May’s announcement did not solve the issue.

Cliff-edge risk is not excluded

Mrs May’s speech gave greater clarity on the objectives pursued by the British government. However, it is all but a closed deal and results will depend on how much the EU and the 27 countries are ready to concede. Brexit talks might not be fractious but with Mrs May contemplating a scenario in which there is “no deal for Britain”, a serious economic shock for Britain and Europe cannot be ruled out.

Expecting to trigger Article 50 by the end of March, Mrs May gave herself only two years to negotiate a comprehensive FTA. This period seems very short. By comparison, it took seven years to conclude the CETA5. Moreover, the PM did not mention her intention regarding the EU financial services “passport” nor did she detail how she plans to deal with the three million European citizens living in the UK and the 1.2 million British expats across the EU, two issues that could prove contentious in the negotiation.

1 Article 50 of the Treaty on EU sets out the two-year process by which a member state may withdraw from the EU.
2 Membership to the single market entails the free movement of goods, capital, services and people (known as the “four freedoms”).
3 House of Commons and House of Lords
4 Treasury Secretary
5 Comprehensive Economic and Trade agreement - EU-Canada FTA