Habemus Brexit!

Economic Outlook | November 16, 2018

Megan Greene, Global Chief Economist, Manulife Asset Management

The Brexit agreement—which took the British government nearly 20 months to negotiate with its counterpart in Brussels—has come under heavy criticism in the United Kingdom, triggering a wave of volatility in the country’s financial market. Our Global Chief Economist Megan E. Greene summarizes the most important points in the agreement and outlines what she thinks could happen next.

Habemus Brexit!

Or at least we’ve taken a step closer to it, although the obstacles ahead are fierce. If the flurry of ministerial resignations and letters sent to prompt an ousting of Prime Minister Theresa May1 in the last 24 hours can be taken as an indication of how difficult it’ll be for Mrs. May to push through her hard-won Brexit deal, she isn’t paying attention to it. Instead, she pledged to forge ahead with her plan, insisting the course she’s set out on is the right one for the country.

What’s in the deal?

Here are the most important points:

  • The transition period essentially looks like the arrangement Norway has—European Union (EU) rules still apply to the United Kingdom, and it won’t have a say in setting them. The transition is set to last until December 2020, but could be extended before July 2020, up to “31 December 20XX.”2 In other words, the transition period could last indefinitely, which will be unacceptable to members of parliament (MPs) who are hard-line Brexiters.
  • The border issue in regard to Northern Ireland will be addressed during the transition period by the United Kingdom remaining in the EU’s Customs Union until a permanent solution is found. I believe this will be a deal breaker for a number of MPs because it could prevent Britain from being able to negotiate its own trade agreements with non-EU countries.
  • The agreement also implies that Northern Ireland will have different rules from the rest of the United Kingdom, as it will be more integrated into the EU’s Customs Union. This has angered the Democratic Unionist Party (DUP), the Northern Irish party, which has been propping up Prime Minister May’s government and has said it will vote against the deal.3 The party is resolute that Northern Ireland mustn’t be treated differently than the United Kingdom.
  • The terms on which the United Kingdom could leave the temporary customs arrangement has also come under fire: Under the agreement, the United Kingdom cannot bring this arrangement to an end unilaterally.
  • The British government had hoped that it could retain unfettered access to the EU’s financial services market, but this would mean splitting up the four freedoms—goods, services, capital, and labor—that lie at the heart of the European project. This was always unacceptable to Brussels, and so financial services will have access to the EU market based on equivalence—if the rules in the United Kingdom are similar enough to those in the EU. The EU can withdraw access in 30 days, which could be a Sword of Damocles hanging over financial service institutions based in the United Kingdom.

How does the math look in parliament?

Now that the cabinet has supported Mrs. May’s deal, parliament will have to vote on it. The parliamentary vote at the moment is on a cliff’s edge—as much as the Brexit referendum itself was.

There are a number of signs that this deal will be rejected—including the resignation of Dominic Raab (the United Kingdom’s Brexit minister), and open calls by prominent Brexiter MPs for a no-confidence vote on Mrs. May’s government.1 While many of us have witnessed how incredibly fractured the Conservative Party is, most have underappreciated how split the opposition Labour Party is on Brexit, too.

The deal has to win a simple majority to pass in parliament. There are 650 MPs in the House of Commons, but due to the way it’s structured, Mrs. May needs 320 votes for the deal to pass.

Mrs. May seems likely to have 235 votes from loyalists in her party and conservative MPs who want to move the national dialogue beyond Brexit, but that leaves another 85 votes. There are some pro-EU Tories who will vote against the deal, not to mention the group of hard-line Brexiteering MPs in the party, who would prefer for the country to crash out of the EU. And, finally, the Northern Irish DUP will probably vote down the deal.

That said, Mrs. May might get some support from the Labour Party—there are a few Labour MPs who are in favor of Brexit, and others who feel obliged to support the deal because their constituents had voted for it. Labour Party leader Jeremy Corbyn has spoken out against the deal, likely hoping to eventually spark an election. Labour MPs will therefore have to choose whether to vote for their party (and future jobs) or their country (if the alternative is crashing out of the EU, which is generally accepted by economists to be the worst possible scenario for the British economy).

Brexit: three scenarios

If the deal passes in parliament, then we’ll at least know what the transition period will look like, if not what shape the final relationship between the United Kingdom and the EU will take. I think the most likely scenario is that a deal will be agreed. The Irish border issue has been at the heart of the negotiations from the beginning, and negotiators have tried to avoid a hard border. In the event of a no deal Brexit, there would be a hard border the next day between Ireland and Northern Ireland—the EU would demand it. Still, this is on a knife’s edge, and there are a number of ways this could go a bit pear shaped.

1 Theresa May is ousted

There are already rumblings of a leadership change in the U.K. government. Realistically, it probably isn’t possible to hold a leadership challenge and renegotiate the Brexit deal before Article 504 runs out on March 29, 2019, and so the country might, in this scenario, seek an extension of Article 50. This can be granted if all EU member states agree to it, but the EU suggested on Thursday that it has no interest in granting an extension. There’s also a chance that a hard Brexiter who prefers the United Kingdom to crash out of the EU with no deal will take over the role of prime minister, in which case no extension would be needed. Finally, Mrs. May could survive a no-confidence vote should one be triggered—she’s certainly proven her political prowess in the face of high level resignations and political drama throughout the Brexit negotiations.

2 The deal is defeated in parliament and a new referendum is held

If the deal is defeated in parliament (the outcome of which is technically nonbinding), Mrs. May could put it to a referendum. But time is running out—it would be difficult to arrange a referendum before Article 50 expires next March. Furthermore, the referendum is likely to be complex: In addition to asking people whether they accept the deal or not, the referendum would probably also seek to ask what the alternative to the deal should be if it’s rejected. Here, there are two options: canceling Brexit altogether, or crash out of the EU. Opinion polls suggest that when given the choice to stay in the EU versus leaving without a deal, a slim majority of people would vote for the former.5 But again, we saw how that played out in the Brexit referendum. Furthermore, there would be two Brexit options versus one Bremain option on the table, and so support for Brexit would necessarily be divided. Some Brexiters may claim that’s unfair.

3 A fresh election before Brexit

I think this option is the least likely, and that it would solve very little. If there’s one thing that unites the Tory Party, it’s the fear that the opposition Labour Party could sweep into power. I think this will keep the government together through Brexit.

What it means for the U.K. economy

I’ve long argued that any form of Brexit would hurt the U.K. economy—the country’s growth prospects would be much brighter with continued EU membership. It’s near impossible to provide an accurate forecast of what U.K. growth would be like post Brexit: it depends entirely on the choreography of Brexit, most of which depend on what happens next politically. Volatility is the only certainty in the days ahead. We’ve already seen that in the currencies market—the way the British pound (GBP) moved in tandem with the drama-filled Brexit headlines in the last 48 hours. Expect this sort of volatility to continue for the 130-odd days we have remaining until Brexit is meant to happen. In my view, a revote that takes Brexit completely off the table is the scenario most likely to boost both the GBP and the FTSE 100 index.

Mayday for the British pound

Mayday for the British pound Chart
Source: Bloomberg, as of November 16, 2018.
1 “No confidence letters: List of MPs who have issued Theresa May with no confidence letters,” Express, November 16, 2018.
2 “Draft agreement,” European Commission, November 14, 2018.
3 “The 10 DUP MPs could scupper the Prime Minister’s deal if they vote against the motion,” iNews, November 15, 2018.
4 Article 50 is part of the Lisbon Treaty which sets out the legal and political process in which an EU member state leaves the union.
5 “Majority of Brits now against Brexit and back second EU referendum,” Sky News, November 15, 2018.
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