Brexit : Current status : Slough of Despond

Peers, including Conservative peers, opposed Boris Johnson’s law-breaking Brexit bill. The legislation provoked renewed tensions between the United Kingdom and the European Union as it was accused of paving the way to override the withdrawal agreement on the use of state aid and the customs check required on goods crossing the Irish Sea. A motion against this bill was passed by a majority of 226 – which is the biggest defeat for the Conservative Party in more than 20 years. In the meantime, there is still a great deal of uncertainty regarding the evolution of negotiations. The EU and UK negotiators Frost and Barnier are engaging on Twitter, but it is unknown at this stage whether negotiations will restart in the coming days.

Reaching an agreement by mid-November will require a breakthrough regarding four main issues:

1/ The United Kingdom will have to provide much more clarity on enforcement of level-playing field. The EU is especially worried concerning state aid and the implementation of credible mechanisms to control and enforce subsidy decisions. The negotiators are essentially hesitating between two options: domestic regulation or dispute settlement;

2/ The United Kingdom will have to accept to remove the most controversial clauses from the Internal Market Bill which refers to the joint market across England, Scotland, Wales and Northern Ireland in post-Brexit. This bill makes sure that trade will remain barrier-free between all four home nations, but the EU worries about potential implications for Northern Ireland which shares a border with the Republic of Ireland - an EU member state;

3/ The EU, and especially France, will need to make concession on fish, starting from acknowledging that it would be unfair that the same level of quota applies while the United Kingdom will become a non-EU coastal state. This hot topic has been for a long time subject of frustration in Paris and in London. To work around this problem, the EU has proposed concessions on the United Kingdom’s future access to the single energy market in return for fish, but it is considered as an insufficient effort by the UK government;

4/ We are not talking about agreeing 20 or 30 pages of trade deal. We are talking about a wholly new treaty of at least hundreds of pages. It will require time for lawyers to revisit the new treaty and for translation into other languages before the start of the ratification process. This challenge is not impossible, but it will imply celerity and goodwill from all the involved parties and probably a dose of political intervention on both sides.

Despite all the recent Brexit noise, we still expect a “thin” agreement at the last minute. The UK government has recently mentioned the possibility of a “Australian” type of deal, but it would essentially consist in a no-deal. It would certainly not be the best option from an economic point of view. Despite being confident on the future of the negotiations, we cannot exclude the possibility that the UK and the EU might not come to an agreement by the end of the transition period. It would not be necessarily a disaster and it could even have the undeniable advantage of introducing an element of realism in the negotiations. A few months of no-deal Brexit could finally encourage both parties to make decisive concessions to reach an agreement as the UK but also Germany, France, the Netherlands and Ireland (four of the most vulnerable EU countries to Brexit) would experience the real economic cost of a no-deal. To mitigate the economic impact of a no-deal, we can assume that the EU would offer emergency financial assistance to the four mentioned EU member states and that the United Kingdom would resort to further monetary policy measures (such as negative rates and increased QE) but also new policies to protect consumer’s purchasing power (such as consumption vouchers and extended VAT cut) and liquidity measures targeting companies. At the end of the day, we think the currency market is right, there will be a deal.