Britain is likely to remain half in and half out of the EU after more high drama in the Brexit saga, says Robeco Chief Economist Léon Cornelissen.
It follows the resignation on Monday of two of the most senior British Cabinet ministers, in protest at proposals by UK Prime Minister Theresa May to essentially stay in the EU’s Single Market for goods.
Brexit Secretary David Davis and Foreign Secretary Boris Johnson both quit the Conservative government following a weekend Cabinet summit that had attempted to thrash out a compromise plan. May wants to maintain a frictionless market and retain an important role for the European Court of Justice while restricting freedom of movement – a so-called soft-Brexit.
Davis and Johnson support leaving the EU entirely on the due date of 29 March 2019, creating a ‘hard-Brexit’ with no access to the Single Market or Customs Union. However, this creates a massive problem in how to police the border between Northern Ireland and the Republic of Ireland if the UK leaves the Single Market without an alternative in place.
“The upshot is that the UK is moving inexorably to a Brexit-In-Name-Only (BRINO), which is the most benign outcome for investors,” says Cornelissen. “Quite simply, the alternatives are far worse, despite what the EU would probably call the latest ‘comedy’ in this long-running saga.”
“May has failed to kick the can down the road any further, but she does now have a 120-page white paper (still to be published) finally offering a soft-Brexit strategy, and that’s very positive. She has given up on many of the ‘red lines’, and it is a step in the direction of a BRINO, though of course it has also created risks for the government in that it won’t appease the hard-Brexiteers.”
“The beauty of the idea is that it would solve the Irish border problem, but the EU will still see it as cherry picking because it includes the desire to curtail the free movement of labor, which is another red line for the EU. So, she will need to make even more concessions to get it agreed.”
“And time is running out, as there needs to be sufficient progress by October on the three priority subjects of the Irish border, what to do with millions of expats, and the final divorce bill. Otherwise the UK faces crashing out without a deal.”
Cornelissen says compromise – both within the warring Conservatives and with the EU – is inevitable because the four alternatives for the government are far worse.
“Firstly, there is now speculation about a leadership challenge within the Conservative party, and even calling fresh elections in the UK. Both are unlikely, as the hard-Brexiteers probably won’t be able to get the support of 48 Members of Parliament needed to challenge May, and it is even more unlikely that a hard-Brexiteer would take the reins of the Tory party. The far more likely scenario is that the UK government will struggle on.”
“Secondly, some say there is now room for a second referendum on leaving the EU, which also seems highly unlikely, as public opinion has not moved sufficiently against Brexit, although demographics are slowly changing the balance in favor of Remain. And time is too short for a well-organized referendum now.
“Thirdly, the UK could ask for a delay in leaving the EU on 29 March, which in theory is possible if all other EU member states agree – though this is also highly unlikely, since the EU would say that this ‘British comedy’ has lasted long enough, and it may be viewed as a negotiation tactic that would be rejected anyway.”
“Finally, crashing out of the EU with a no-deal Brexit in March 2019 is unthinkable; trade would basically come to a standstill, travel would be disrupted, and sterling would crash. The UK government hasn’t made any preparation for this, so this option has to be ruled out. A hard Brexit would similarly be devastating to the UK economy and we basically have to rule out this option as well.”
Muddling through is still preferred by markets, and is the only practical option available, Cornelissen says.
“What is much more likely is the UK government will eventually give in to EU demands, at least for the time being, so that some sort of progress towards a deal can be made that is sufficiently credible. And then of course we’re basically back at standstill, pending a more definitive trading arrangement between the EU and UK, which could take years to negotiate.”
“It seems there is much truth in an old quip about the UK, that it would spend the first ten years trying to get out of the EU, and the next ten years trying to get back in.”
“In the meantime, investment will be harmed and sterling will continue to be seen as a risky currency. All eyes will start to focus on what the Bank of England will do when it next meets to set rates on 2 August. Markets are currently pricing in a 74% chance of a rate hike at the next MPC meeting, which is understandable given the recent rhetoric, but is still unlikely in our opinion, partly given the ongoing uncertainty hampering long-term investment. On the other hand the number of vocal hawks on the MPC is rising, so you never know.”