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Striking new EU deals – possibilities and probabilities

Two years of negotiations with the EU will be triggered when Westminster formally notifies Brussels of the UK’s intention to secede. So what lies ahead? Edward Smith, Asset Allocation Strategist, Rathbones looks at some of the possibilities and the probabilities

As political strife continues to envelop the UK Parliament, a profusion of question marks remain after the Brexit vote. The Conservatives are gearing up to anoint a new leader and prime minister while the Labour Party is in disarray as it collapses around a lame duck who has dug his feet in. Several companies across industries have admitted they are reviewing their UK operations and whether to relocate; however, the lasting economic implications will not be known for many years.

Will the UK be able to negotiate continued access to the free trade area? Further out, what will happen to the EU without the UK? Will it continue to integrate further, dismantling the remaining barriers to trade and investment? This would likely mean the UK losing much of its considerable market share of European trade. Or will the entire EU project stall?

In the event that Brexit sparks a disintegration of the EU, it is wrong to think that our island will be insulated from the economic and market consequences. Trade is sticky: financial and commercial interlinkages between the UK and the eurozone will remain strong for at least another decade. Thankfully, however, despite a swelling tide of euroscepticism on the Continent, the case for other countries leaving is far weaker than the UK’s. They have higher levels of intra-regional trade, tremorous banking systems dependant on the buttresses erected by the ECB and the council of finance ministers, and most nations are just too small to stand a better chance of negotiating trade deals alone.

New trade deals

If Brexit requires the UK to forsake access to the European Single Market, it is imperative that Britain works hard to enact new trade deals and sign new agreements of economic integration with faster growing economies than the EU. With an ageing workforce, productivity will be the key driver of economic growth in Western economies in the 21st century and such deals will be required to drive that.

The UK should retain access to the single market for the roughly two years it will take to negotiate a new deal once the UK invokes Article 50. Unfortunately, we are unconvinced that retaining access to the single market on beneficial terms thereafter will be easy to negotiate. The Norwegian model should be unpalatable to those who voted for Brexit: Norway must make a sizeable contribution to the EU budget and pass EU laws on to their own statute books without any representation in the bodies which draft them. The Albanian/Balkan model, rather comically referred to by Michael Gove, is not realistic either. This deal is arguably a matter of international aid and not something that will be offered to a large, developed nation – and certainly not one that has just kissed them adieu.

This leaves us with a complex series of bilateral directives à la Switzerland. However, Switzerland does not offer a replicable model either, not least because most of its directives were agreed before 2006, when becoming a member of the EU was still a ‘strategic goal’ of the Swiss government. We are likely to end up with our own unique – and probably complicated – relationship with the eurozone.

Increased tariffs

That said, if the UK must withdraw from the free trade area, tariffs on exports to the EU would be just 3.3% on a weighted average basis. Given that the business models of most UK exporters are not predicated on being the lowest cost producer – and that sterling has already depreciated by 14% since its November peak (more than offsetting the imposition of tariffs) – this is hardly likely to lead to a collapse in trade. Some goods exporters will be subject to more punitive tariffs under this ‘hard Brexit’ scenario, however, especially automobile, clothing and agriculture businesses.

Financial services most at risk

Financial services are most at risk from the new order. The UK has an enormous trade surplus in financial services with Europe. Various EU institutions have tried to forcibly repatriate with new legislation a number of financial activities over the last five years (both successfully and unsuccessfully, due to the UK’s former recourse to the European Court of Justice).

The likelihood of a deal on financial services – a sector on which the UK’s economy is still heavily dependent – is decidedly uncertain.

 

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