The UK will no longer be a member of the European Union (EU) after 23:00 GMT on 31 January 2020.
As our readers know, we were amongst the very few to predict the BREXIT vote outcome as early as February 2016 and our conclusions were that BREXIT would actually be good for both the UK and for Europe.
What we did not expect then was that it would take almost three years for the divorce to actually happen – we should have known better considering the way divorces usually go – and we are finally here now at the end of January 2020.
Brexit started many years ago as a segment of the UK population felt that Europe’s constraints were too stringent for the United Kingdom and that the UK was paying more to Europe than it was receiving.
This political narrative ultimately led to a referendum that was held in June 2016, when 17.4 million people opted for Brexit. This gave the Leave side 51.9%, compared with 48.1% for Remain.
Our call that the UK would choose to leave the UK in February 2016 was based on our analysis that the United Kingdom is the oldest Monarchy in Europe and its land has never been invaded since William the Conqueror and the battle of Hastings in 1066.
The Britsh Empire ruled the world for a good two centuries and the British identity is a deeply entrenched sentiment with the population of the UK to this day. It is obviously extremely strong with the older generations that fought the first and second world wars and won them both, even at the cost of losing the British empire.
The UK joined the European Union in 1973 when it was known as the European Economic Community.
The EU is an economic and political union involving 28 European countries. It allows free trade, which means goods can move between member countries without any checks or extra charges. The EU also allows free movement of people, to live and work in whichever country they choose.
The creation of the European Union and the subsequent creation of the single currency triggered significant increases in living standards and economic efficiency in the Southern and Eastern European nations while giving corporations of the Northern countries a much larger natural market for their products and services.
The United Kingdom benefitted strongly from the Union and the single market but was always reluctant to abandon what it considers to be essential elements of its sovereignty such as its currency.
The population of the UK is far more attached to its Monarchy and National identity than the population of continental Europe and the younger generations of continental Europe have already embraced the concept of their European Nationality while the youngsters of the UK still relish their insularity.
Our point has always been that there was a major disconnect between the UK’s vision of the European Union and the Continental European vision of the EU.
The UK always considered the European Union as a commercial Union and a unified economic zone and has always been suspicious of the political union and abandoning parts of its Sovereignty
While for continental Europe, and France in Germany in particular, the European Union is, above all, a political Union, and a dire necessity after two world wars that saw millions of deaths and entire cities destroyed.
The divorce was, therefore, a logical conclusion and we do believe that it will ultimately end up being positive for both the UK and Europe.
The UK will be able to capitalize on its singularity and will offer a fantastic independent and neutral “offshore” financial markets in a time zone between Europe and America, and we already see Chinese corporations, who are very familiar with the British culture, legal system and business mentality taking a very strong interest in the UK for their headquarters in this part of the world, with a privileged access to Europe while having an independent legal system.
In this decade where China will become the leading economic and geopolitical power of the world, we are extremely confident in predicting that the ties between China and the UK will become extremely close and strategic for the two nations.
For the European Union, the departure of the UK will remove a considerable force of inertia against further European integration. Now that the UK is out of the European Union, France, Germany and other nations such as Spain or the Netherlands will certainly initiate a new momentum towards more political integration and eventually a true Federation of Nations. or a Confederation modeled on the Swiss system.
Following the creation of the Schengen Area in 1995, an area of 4 300 km2 and 420 million people comprising 26 European states that have officially abolished all passport and all other types of border control at their mutual borders, and functions as a single jurisdiction for international travel purposes, with a common visa policy, the European Union is in deep need of a unified foreign affairs policy framework, of a unified defense framework, of a unified border control police and even a unified criminal police backed by harmonized legal and judiciary procedures.
On the economic front, Europe’s Monetary Union has always been seen as an incomplete construction as the unified monetary policy could contradict the Nationa budgetary policies. The UK has always been vetoing any kind of European taxation that would give the European Commission more powers and the European Union more elements of sovereignty.
There again we are extremely confident in predicting that over the coming decade, we will see a strong political evolution towards a more politically integrated European Union with elements of a Federal State.
And frankly, it will become the choice if the Continental European populations to finally decide whether our world will be a bi-polar world with the USA and China dominating the political and military scene, or if our world will become a tri-polar, and therefore, more secure world with three blocs of almost equal importance counterbalancing each other.
What happens after Brexit day?
After the UK formally leaves the EU on 31 January 2020, there is still a lot to talk about and months of negotiation will follow. While the UK has already agreed to the terms of its EU departure, both sides still need to decide what their future relationship will look like.
This will be worked out during the transition period – the implementation period – which begins immediately after Brexit day and is due to end on 31 December 2020.
During this 11-month period, the UK will continue to follow all of the EU’s rules and its trading relationship will remain the same.
What needs to be agreed upon?
The transition period is meant to give both sides some breathing space while a new free trade agreement is negotiated. This is needed because the UK will leave the single market and customs union at the end of the transition. A free trade agreement allows goods to move around the EU without checks or extra charges.
If a new one cannot be agreed on time, then the UK faces the prospect of having to trade with no deal in place. That would mean tariffs (taxes) on UK goods traveling to the EU and other trade barriers.
Aside from trade, many other aspects of the future UK-EU relationship will also need to be decided. For example:
- Law enforcement, data sharing and security
- Aviation standards and safety
- Access to fishing waters
- Supplies of electricity and gas
- Licensing and regulation of medicines
Prime Minister Boris Johnson insists the transition period will not be extended, but the European Commission has warned that the timetable will be extremely challenging.
What is the Divorce deal?
The transition period and other aspects of the UK’s departure were agreed upon in a separate deal called the withdrawal agreement.
Most of that was negotiated by Theresa May’s government. But after Boris Johnson replaced her in July 2019, he removed the most controversial part – the backstop. The backstop was designed to ensure there would be no border posts or barriers between Northern Ireland and the Republic of Ireland after Brexit. If needed, it would have kept the UK in a close trading relationship with the EU.
Under Mr Johnson’s deal, a customs border will effectively be created between Northern Ireland and Great Britain. Some goods entering Northern Ireland from Great Britain will be subject to checks and will have to pay EU import taxes. These would be refunded if goods remain in Northern Ireland.
Supporters of the new customs arrangement say it will allow the UK to negotiate its own trade deals with other countries – something that would not have been possible under the backstop.
The rest of the withdrawal agreement is largely unchanged from the one negotiated by Theresa May. This includes:
- The rights of EU citizens in the UK and British citizens in the EU (which will remain the same during the transition)
- How much money the UK is to pay the EU (estimated to be down to about £30bn)
Why did it take so long?
Brexit was originally meant to happen on 29 March 2019, but the deadline was delayed twice after the British Members of Parliament rejected the deal negotiated by Mrs. May, the prime minister at the time.
Many Conservative MPs and the DUP (the government’s then ally in Parliament) were unhappy with the backstop – arguing that the UK could remain trapped in the arrangement for years with no way out. After the British Parliament voted down the deal for a third time, Theresa May resigned.
Boris Johnson needed a Brexit extension of his own after MPs failed to get the revised deal passed into law. This led to the new deadline of 31 January 2020.
With Parliament still in deadlock, Mr Johnson called an early general election, to which MPs agreed. The election took place on 12 December 2019 and resulted in a re-inforced Conservative majority of 80.
With a sizeable majority in Parliament, it proved its ability to pass the Brexit legislation.
What are the challenges now?
The first is that, while the size of the government’s majority in parliament has strengthened its hand in negotiations with Brussels, Brexit uncertainty is likely to hang over the economy for at least the remainder of 2020.
In the extreme, the UK may face yet another cliff-edge exit at the end of this year, when the transition period within the EU Withdrawal Agreement is due to expire.
A more likely outcome, given the history of Brexit to date, is more fudge – with perhaps a “phase one” deal covering the basic elements of goods trade between the UK and EU agreed by the end of this year and the more thorny issues around services trade, market access and financial services kicked down the road.
Whatever the outcome, however, the post-Brexit landscape will remain uncertain for a while, dashing any hopes of an imminent upswing in business investment.
A plausible reason to expect an improvement in the UK’s economic performance this year stems from the fact that fiscal policy is set to be loosened significantly.
The exact scale of the stimulus will not be known until the Budget on 11th March.
But we already know from September’s spending round that day-to-day government expenditure will increase by 0.6% of GDP in the fiscal year 2020-21. And the Conservative’s election manifesto suggests that an increase in public investment is also in the pipeline.
Putting all of this together, it looks like fiscal policy will be loosened by around 1.0% of GDP over the next couple of years.
What’s more, the nature of the stimulus is likely to be skewed towards the elements of government spending that have a higher fiscal multiplier
The chart below courtesy of Capital Economics compares the size of the stimulus derived from it in the UK and its likely boost to economic growth, to that implemented by the Trump administration in the US in 2018.
A large part of the Trump stimulus came from tax cuts that were tilted towards the upper end of the income distribution and carried a relatively low fiscal multiplier.
In contrast, the UK stimulus is likely to have a large component of capital investment, which carries a high fiscal multiplier.
The net result is a bigger impact on overall GDP growth.
Admittedly, UK GDP growth is likely to remain relatively lackluster, not least because of the continued headwinds from Brexit uncertainty.
But looser fiscal policy should support a pick-up in growth from 1.0% this year to around 1.8% in 2021.
In addition, Monetary policy could be looser than expected by the market. Already, the early weeks of this year have seen a remarkable repricing of the likelihood of interest cuts in the UK.
Just three weeks ago, markets put the probability of an interest cut at this Thursday’s the Bank of England Monetary Policy Meeting at around 10%. By the start of last week, however, that had risen to 65%.
It goes without saying that the outcome of this coming Thursday’s meeting is on a knife-edge.
Two out of nine MPC members voted for a cut in December. That may not sound like a big deal, but it’s worth noting that of the 12 previous instances when two members have voted for cuts, the MPC has subsequently loosened policy in 10. However, things could be different this time around.
December’s MPC meeting – and, indeed, dovish comments from several committee members since it – predate more recent data showing that the economy may be starting to find its feet.
The past week has brought tentative signs that the housing market is improving, manufacturing is turning a corner and hiring is picking up. If that wasn’t enough then the flash PMIs for January, released on Friday, put the icing on the cake, with the composite manufacturing and services index jumping to its highest level since late 2018.
In other words, most of the very recent data coming out of the UK point to an economy that is recovering from uncertainty
This could very well dissuade the MPC from cutting interest rates this week.
And, by the time the MPC next meets in March, the Budget will have happened and it will be able to factor full details of the impending fiscal stimulus into its forecasts.
Accordingly, and in contrast to the growing view in markets, we think interest rates will remain unchanged this week and throughout the course of this year.